PUBLIC FINANCE

UNIT-1
PUBLIC FINANCE MEANING
Public finance is the study of financial aspects of government (Central, State and Local
government). It is one of those subjects which lies on the border line between
economics and politics. It deals with income raising and expenditure incurring activities
of the public authorities.
The classical economists starting with Adam Smith includes Public Finance as an
integral part of economic theory in his book, “An Enquiry into the Nature and Causes of
Wealth of Nations.” He included certain aspects of taxation, public expenditure and
public debt. Later, classical economists especially Ricardo deals with different aspects
of taxation, public expenditure and public debt as a part of economic theory.
DEFINITION OF PUBLIC FINANCE
According to Dalton, “Public finance deals with income and expenditure of public
authority and with the manner in which one is adjusted to other.”
According to Hicks, ”The main concept of public finance is the examinations and
appraisal of the method by which governing bodies provide for the collective satisfaction
of wants and secure the necessary funds to carry out their purposes.”
SCOPE OF PUBLIC FINANCE
Prof. Dalton divided the scope of public finance into four categories-:
1. Public revenue or income- The main source of public revenue are taxes, fees,
fines, special assessment and commercial revenue from public undertakings, etc.
In this we study the canons and principles of taxation. Various direct and indirect
tax and their impact, the problem of tax evasion and avoidance and the
measures to solve these problems, so as to raise public revenue.
2. Public expenditure- It is the beginning and end of the collection of revenue by
the government. Under public expenditure we study its classification, canons and
the principles which governs its effect on production, employment, income
distribution, stability and growth.
3. Public debts- When public revenue fall short of public expenditure, the
government borrows from the public to meet this gap, this is known as public
debt. Under this we study the reasons, sources of public debt and its effect on
production, consumption, income distribution, etc.
4. Financial administration- The aim of financial administration is to control the
process and operations of public revenue, expenditure and public debt. The
scope of financial administration is collection, custody and the disbursement of
public money, the coordination of expenses according to well-formulated plans,
the management of public debts and the general control of financial operations of
the state. It also includes the preparation of budget and its execution and above
all auditing the finances of the state.
 FUNCTIONS OF PUBLIC FINANCE

1. THE ALLOCATION FUNCTION- The allocation function deals with the allocation
of such public goods. The government has to perform various functions such as
maintaining law and order, defense against foreign attacks, providing healthcare
and education, building infrastructure, etc. The list is endless. The performance
of these functions requires large scale expenditure, and it is important to allocate
the expenditure efficiently. The allocation function studies how to allocate public
expenditure most efficiently to reap maximum benefits with the available public
wealth.
2. Distribution function- The distribution function of public finance is to lessen
these inequalities as much as possible through redistribution of income and
wealth.
3. Stabilization function- Every economy goes through periods of booms and
depression. It’s the most normal and common business cycles that lead to this
scenario. However, these periods cause instability in the economy. The objective
of the stabilization function is to eliminate or at least reduce these business
fluctuations and its impact on the economy.

NATURE OF PUBLIC FINANCE

Public finance is a social science which is concerned with the problem of raising funds
and their allocation for the collective satisfaction of wants. It is a method of study based
on both the study of principles and theories.
It is the principle which is in nature of generalization with state, the cause and effect
relationship with different variable like public revenue, debt, expenditure and financial
administration. It is concerned with fiscal policy which influence economic policies and
economic structure of the country.
IMPORTANCE OF PUBLIC FINANCE
1. Expansion of state activities- Public finance is important because now the
activities of state are not only confined to looking after the security of life and
property against foreign aggression but also are concerned with protection
against internal disorders, regulation of trade and commerce, development of
industry and planned economic development of the country.
2. Growing use of money- Another reason for increasing importance of public
finance has been growing use of money in all spheres of life, all the functions of
the state came to be performed through this medium.
3. Emergence of generalized services- The importance of public finance has also
increased due to emergence of generalized services which can be performed
more conveniently, efficiently and also at the minimum cost. Such services are
education, health, social security, etc.
4. Reduction in economic inequalities- Public finance can play a vital role in
reducing economic inequalities which is a source of dissatisfaction, class-
struggles, poverty, etc. The state can do this by levying heavy taxes on richer
 sections of society and thereby spend the income so received on providing food,
cheap housing, etc. for poorer section of the society.
5. Increase employment- Public finance can play a vital role in increasing
employment as the government can establish industries, give grants, subsidies,
provide exemption from excise duty, taxes, etc.
IMPORTANCE OF PUBLIC FINANCE IN UNDERDEVELOPED OR DEVELOPING
COUNTRY
1. Capital formation- Since, development of the country is dependent upon capital
formation so one of the importance of public finance is capital formation. For an
underdeveloped and developing economy the burning problem is of capital
formation.
2. Planned economic development- In underdeveloped or developing countries
the productive resources are limited in quality as well as quantity so, public
finance renders valuable help in the planned economic development of the
country by utilizing such resources in the best possible way.
3. Unemployment problem- Another major problem of underdeveloped or
developing economy is unemployment. So, public finance help in reducing
unemployment by the directing the public funds in generating employment
opportunities for people.
4. Increase in income- Public finance with the help of public expenditure increases
the income in underdeveloped or developing economies by investing the funds in
industries in such an economical and efficient manner that least amount of
money can yield maximum output.
5. Reduction in economic inequalities- Another problem of underdeveloped and
developing economy is the unequal distribution of income and wealth which can
be reduced with the help of public finance by taxing the richer sections and
transferring the benefits derived from such revenue to the poorer section.
6. Optimum utilization of resources- In underdeveloped or developing economy
public finance helps in optimum utilization of resources by means of adopting
planned monetary and public finance policies.
7. Problem of economic stabilization- In underdeveloped or developing country
there exists economic instability so public finance may be used to remove such
instabilities in the economy through revenue and expenditure process of the
government.
8. Incentive to savings- One of the major problem of developing or
underdeveloped countries is that savings are very nominal which hinders
economic development so, public finance encourages the accumulation of
savings.
SIMILARITIES BETWEEN PUBLIC AND PRIVATE FINANCE
1. Satisfaction of human wants- Both public and private finance are concerned
with satisfaction of human wants. Public finance is concerned with satisfaction of
social or collective wants of human beings and private finance is concerned with
satisfaction of individual wants.
 2. Maximum advantage- Both public and private finance try to secure maximum
advantage or benefit for the expenditure incurred by them.
3. Borrowings- Both public and private finance have to resort to borrowings in
times of crisis or when expenditure exceeds income.
4. Problem of adjustment of income and expenditure- Both public and private
finance face the problem of adjustment of income and expenditure.
5. Scarcity of resources- The scarcity of resources is also an important factor
which is common to both. They have unlimited ends whereas the resources are
limited.
6. Repayment of loans- Both the public and private finance are required to repay
the loans sooner or later as obtained by them during deficit.
7. Contribution to national product- The financial activities of both public and
private finance give birth to saving, capital accumulation and investment activities
by which production, consumption and investment activities are boosted in a
country and thereby they contribute to national product.
8. Efficient management and administration- Both the public and private finance
needs efficient management and administration. In the event of the collapse of
efficient management and administration, both are compelled to face dire
consequences in the financial matters.
DISSIMILARITIES OR DIFFERENCES BETWEEN PUBLIC AND PRIVATE
FINANCE
1. Motive- The motive of private finance is personal interest or benefit, whereas the
motive of public finance is social benefit or public welfare.
2. Adjustment approach of income and expenditure- Every individual tries as far as
possible to adjust his expenditure as to his income because his expenditure is
governed by his income. He follows the principle of ‘cut your coat according to cloth’.
On the contrary, the government first determines its expenditure and then devices
ways and means to raise the necessary revenue (income) to meet the expenditure.
The government follows the principle of ‘cut your cloth according to coat’.
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
as it can borrow from the internal as well as external sources.
4. Coercive methods- An individual cannot use coercive methods to raise his income,
whereas the government can use coercive methods to collect revenue, e.g. tax
cannot be collected without using coercive methods by the authorities.
5. Nature of the budget- An individual usually thinks in terms of surplus budget, that is
spending less than income and thus a deficit budget (spending more than income) is
always considered undesirable. On the other hand, the government may find it
useful to have a deficit budget, especially in times of economic development, war,
etc.
6. Secrecy of budget- Secrecy of budget prevails in case of private finance whereas
public finance is open to all.
7. Long/ short-term considerations- Private individual incur expenditure in those
fields of business where returns are quick and immediate. On the other hand
 government incur expenditure keeping in view the long-term considerations, such as
construction of multi-purpose hydroelectric projects in India, five year plans, etc.
8. Elasticity of finance- Public finance is more elastic as compare to private finance.
As a matter of fact, there is not much scope for changes in private finance while
drastic changes can be made in public finance, such fresh imposition of new taxes.
PUBLIC vs. PRIVATE GOODS
Public goods- Public goods are the commodities or services provided by the nature of
the government of a country, free of cost or by taxing the few people to offer mass
benefit to the public in general.

Characteristics of Public Goods

These commodities or services develop the infrastructure and living standard of a

country. To know more about public goods, let us go through its following features:

 Non-Rival: The public goods are non-competitive, i.e. it can serve many people at
the same time without hindering the usage of one another.
 Non-Excludable: These goods are usually free of cost and can be used by
anyone without any restriction.
 Non-Rejectable: The consumption of such goods cannot be dismissed or
unaccepted by the public since it is available collectively to all the people.

Private goods- Private goods are the products or services which are manufactured or
produced by the companies owned by entrepreneurs who aim at meeting customer’s
requirement to earn profits through the trading of such goods in the free market.

Characteristics of Private Goods

Private goods serve the personal needs of consumers. Following are the various
characteristics of these goods:

 Rival: The private products involve rivalry or competition among the consumers
for its usage since the consumption by one person will restrict its use by another.
 Excludable: These goods involve cost, and therefore the non-payers are
excluded from the consumption.
 Rejectable: Private goods can be unaccepted or rejected by the consumers since
they have multiple alternatives and the right to select the product according to
their preference.

DIFFERENCE BETWEEN PUBLIC GOODS AND PRIVATE GOODS

ASIS PUBLIC GOODS PRIVATE GOODS

Meaning Public goods are the ones Private goods are the ones which are
ASIS PUBLIC GOODS PRIVATE GOODS

which are provided by the manufactured and sold by the private

nature or the government for companies to satisfy the consumer
free use by the public. needs and wants.

Provider Nature or government Manufacturers i.e. entrepreneurs

Consumer Rich and poor are treated Preference to rich consumers

equality equally

Availability Readily available to all Reduces with each consumption

Quality Remains constant Varies with ability to buy

Decision Social choice Consumer's decision

Objective Overall growth and Profit earning

development

Traded in No Yes
Free Market

Opportunity No Yes
Cost

Rivalry Non-rival Rival

Excludability Non-excludable Excludable

Examples Police service, fire brigade, Clothes, cosmetics, footwear, cars,

national defense, public electronic products and food
transport, roads, dams and
river
PUBLIC FINANCE AND OTHER SCIENCES
Public finance is related to other sciences; the subject matter of public finance is of such
a nature that its study cannot be separated from that of other sciences. Following are
the various other sciences to which public finance is related-:
1. Public finance and economics- Public finance is considered to be a branch of
economics. In the economy, public finance involves raising and spending of
funds by the government authorities. The principles of economics are considered
in the formulation of policies for the public revenue and public
expenditure.  Hence, public finance and economics are interrelated.
2. Public Finance and Political Science- The principles which underlie a study of
expenditures and revenues have a dependence upon Political Science second
only to that which they have upon Economics. The form of government under
which the citizens live and the officials work is of the utmost importance.
Differences in the method of conducting fiscal affairs would necessarily be found
in states of autocratic, democratic, socialistic or individualistic government
tendencies.
3. Public Finance and History- It is only a poor fiscal policy which took no
consideration of the activities of the past, with their resulting successes or
failures. A study of history, consequently, is an invaluable asset in helping to
formulate modern fiscal policies that is why public finance is related to history.
4. Public Finance and Statistics- Public Finance is closely related with statistics.
Numbers and figures involve in public revenue, expenditure and debt make good
sense and it is more presentable when it is reduced with the aid of statistics. In a
bid to determine the rate of capital formation, taxable capacity, incidence of
taxation, preparation of budget etc statistics is quite handy and indispensable.
Simply put, there is no public finance without statistics.
5. Public Finance and Sociology- Social reforms which form core part of the
subject matter of sociology, are supposed to be the responsibility of the
government. These reforms require huge fund that will come from the purse of
the government. It is the social reforms that usually enhance the scope of the
public expenditure. Taxes on inheritance, gifts and others may have their due
effect on the social set up of the society. The problems of social reform and those
of Public Finance are, at present, inseparably related.
6. Public Finance and Psychology- It deals with people and as such, most of its
problems are human-problems and hence depend upon human behaviour that is
the subject matter of psychology. For instances, profit is generally seen as
reward for taking a particular risk,  when the profit arising from this risk taking
venture or company is tax heavily, it may adversely effect of the spirit of risk
taking. Thus, it will have effect on the investment of the company or the industry.
7. Public Finance and Law- The fiscal policy of a country, in general, is always
based on the principles of equity and justice. All these have been borrowed from
jurisprudence and in fact, are based on the foundation of legal definitions. The
law of the country is the bases on which taxes are imposed and funds are
allocated. There are laws that prevent improper allocation.