Public Finance - A Brief Guide

Public Finance 

As you all know my website is related to Hospitality and hotel management with over 1000 + articles, today's post is something different from Hospitality. I have shared some of my knowledge on public finance. It's a free subject so, having a little knowledge of public finance can be beneficial to understand about economy and how things are going on, in field of economy across the world. 

Public finance deals with public sector of economy. It is the finance related to public economics as it is field of economics concerned with how government raise money, how that money is spent and the effect of these activities on society. 

It is the study of finance related to government entities. It can be defined as study of income and expenditure of government at both central and local level. It deals only with finance of the government. 

Scope of public administration 

Prof. Dalton gas classified scope of public finance into four areas as follows :-

1. Public income

2. Public expenditure

3. Public debt

4. Financial administration

Public income refers to the the income of the government. The government earns income in two ways- Tax income and Non-tax income. Tax income is the tax paid by people/citizens of the country while Non-tax income includes interest income from lending money to other countries, rent and income from government properties, donation from world organizations.

Public expenditure is the money spent by government entities. Logically the government is going to spend money on infrastructure, defense, education, health care for growth and development of the country. 

When public expenditure exceeds public income, gap is filled by borrowing money from public or from other countries/worlds Bank. These borrowed fund are public debt.

Financial Administration includes Preparation, passing and implementation of government budget and various government policies. 

Importance of public finance

• Government activities are enlarged

• It indicates level of overall borrowing by government

• It is indicator of fiscal health of economy

• It is essential to ensure constant economic growth

• It overcome challenges of inflation and deflation

• Economic stabilization

• Revenue collection

• Developing infrastructure

Classification of public finance

Public finance Can be classified as Macro economical and Micro economical. Macro economical consists of fiscal policy and monetary policy while micro economical consists of industry policy, labour policy, competition policy.

Fiscal policy :-

The word fiscal meant state treasury and it is the policy concerning use of state treasury. There are two types of fiscal policy. Expansionary and contractions. 

Expansionary fiscal policy is used in bad times while contractionary fiscal policy is used in good times.

EXPANSIONARY FISCAL POLICY ( BAD TIMES) :

It is done in bad times and government spends more money in goods and services leading to many job opportunities. It is a form of fiscal policy that involves decreasing taxes and increasing government expenditure. A decrease in tax motivates to invest and also households have more disposable income to spend which increases gross domestic product. 

CONTRACTIONARY POLICY (GOOD TIMES) :

Contractionary fiscal policy involves increasing taxes and decreasing government expenditure to fight inflationary pressure. Due to increase in taxes, households have less disposable income to spend.

Canon of taxation 

Canons of Taxation means qualities which good tax system should posses. It was developed by Adam Smith. They are:

1. Canon of equity

2. Canon of certainty

3. Canon of convenience

4. Canon of economy

5. Canon of Adequacy

6. Canon of variety

7. Canon of Elasticity

8. Canon of productivity

Canon of Equity means taxes should be equal. It states that burden of taxation must be distributed equally among tax payer. However, this sort of equality robs of justice as all tax payers ability to pay is not the same. Rich person are capable of paying more taxes than poor people. To establish equity taxes should be imposed in accordance with principles of ability to pay. 

Canon of certainty states the tax which each individual is bound to pay, should be certain and not orbitary. The time of payment, the manner of payment, quantity to be paid should be clear and plain to everyone. Tax payers should know when, where and how much taxes are to be paid along with tax levying Authority. 

Canon of economy implies that tax should not be too expensive to collect and discouraging to tax payers. 

Canon of convenience states that the levied taxes should be collected in such a manner that it provides greatest convenience not only to tax payers but also to government. 

Canon of productivity states tax should be cost effective.

Canon of Elasticity states that tax should be flexible. It should be levied in such a way that rates of taxes can be changed according to situation. 

Canon of simplicity states that every tax should be simple so that taxpayer is able to calculate it without help of tax consultant.

Canon of diversity states the tax should be diverse. Diverse taxes are better than single or two taxes. If there is only single tax then, large number of sector may be untouched to pay taxes. This system was developed by bastable to evade all of tax. 

Deficit Financing 

As we know, the major sources of public revenue are taxes, fees, prices, special assessments, rates, gifts etc., etc. If during a given period of time, the government expenditure exceeds government revenue and the deficit is met by borrowing, it is called deficit financing or income creating finance. In order to have a significant expansion effects therefore, a program of public investment should be financed by borrowing rather than by taxation. This kind of borrowing or loan expenditure is popularly called deficit financing.

Deficit financing is said to have been practiced if state adopts any one or all the methods mentioned below:

(a) The government draws upon the cash balances of the past.

(b) The government borrows from the central bank against government securities.

(c) The government creates money by printing of paper currency and thus meets the expenditure over receipts.

(d) The government borrows externally.

Deficit financing was considered to be a very dangerous weapon by the classical economists. The modern economists are, however, leaning towards it and recommend it to be used for accelerating economic development and achieving high level employment in the country.

The problem to be solved here is:

(i) Whether income creating finance should be adopted for increasing total effective demand.

(ii) If deficit financing is desirable for ensuring high level of employment, then to what extent should it be carried out.

What are its good and bad effects?

Deficit financing is being practiced by advanced as well as underdeveloped countries. The advanced countries use it as an instrument of increasing effective demand whereas the underdeveloped countries employ it for increasing the rate of capital formation.

The scope of deficit financing for accelerating economic growth in backward economy is very bright as they are caught in a vicious circle of underdevelopment. They use funds for investment when the resources of the country are not adequate to initiate the processes of take off. So arises the need for deficit financing.

The underdeveloped countries are confronted with the following problems:

(i) The rate of growth of population is faster than the rate of economic development.

(ii) The state revenue received through taxes, fees, etc., is not sufficient to provide full employment to the labor force.

(iii) The per capita income is extremely low and so is the capacity to save.

(iv) Foreign loans for development purposes are not without strings and are also not available in desired quantity.

(v) There is a death of stock of capital in the country.

(vi) People lack initiative and entrepreneurial ability.

(vii) People are mostly extravagant and there is less voluntary savings.

(viii) A greater portion of the population lives in villages and are contended with their lot.

(ix) The government cannot incur the displeasure of the people by enhancing the tax rates beyond a certain limit. It cannot also impose additional taxes for the same reason.

(x) Thus there is too much evasion of taxes.