Public finance is concerned with the finances of the Government. According to Dalton, public finance is “concerned with the income and expenditure of public authorities and with the adjustment of one to the other”. Thus, public finance deals with the question of how the Government raises its resources to meet its ever-rising expenditures.
Public finance has mainly two aspects – Public expenditure and public revenue. There are some similarities between public finance and private finance. These are as follows:
- Both have to balance between income and expenditure.
- Both try to maximize benefits.
- Both have to borrow to bridge the gap of current revenue and current expenditure.
- Both can increase their income by increasing their investment.
Difference between public finance and private finance
| Aspect | Public Finance | Private Finance |
|---|---|---|
| Budgeting Policy | Funds are created according to national need (e.g., government allocates budget for infrastructure projects based on national priorities) | “Cut your coat according to your clothes” policy (e.g., individual plans monthly expenses based on income) |
| Surplus vs. Deficit Budgeting | Deficit budgeting policy in most cases (e.g., governments often run deficits to finance wars, economic stimulus packages) | Surplus budgeting policy always followed (e.g., individuals save part of their income for emergencies) |
| Internal Borrowing | Government can borrow from individuals or financial institutions (e.g., U.S. government issues Treasury bonds to finance its operations) | No internal borrowing possible (e.g., individuals typically cannot issue bonds to borrow money) |
| Objective | Maximize social benefit (e.g., government invests in public healthcare and education) | Maximize personal benefit (e.g., individuals invest in personal assets like homes and cars) |
| Deficit Financing | Peculiar privilege of the government (e.g., Japan’s high public debt to finance economic growth) | Individuals cannot practice deficit financing (e.g., individuals must balance their checkbooks to avoid overdrafts) |
| Changes and Flexibility | Deliberate and big changes are easier (e.g., government can adjust tax rates or introduce new policies quickly) | Privacy and confidentiality are paramount (e.g., individuals prefer to keep financial matters private) |
| Time Horizon | Long-term interests like afforestation, public works, social security, etc. (e.g., investments in renewable energy projects) | Short-term benefits appreciated (e.g., savings for immediate expenses like vacations or gadgets) |
| Spending vs. Earnings | State does not need to spend less than it earns (e.g., governments can run fiscal deficits) | Individual always spends less than he earns (e.g., individuals aim to live within their means) |
| Secrecy and Publicity | Needs great publicity (e.g., public budgets and financial reports are published) | Secrecy surrounds individual finance (e.g., personal bank statements and expenses are private) |
| Authority | Government has coercive authority regarding taxation, loans, deposits, etc. (e.g., IRS collects taxes in the U.S., enforcing compliance) | Individuals do not have such authority (e.g., individuals cannot compel others to pay them money) |
Public expenditure
Public expenditure refers to that portion of national income that is spent for public works like the maintenance of state sovereignty, employment of the people, and increasing the income and standard of living of the people.
Causes of the Increase in Public Expenditure
Increase in the Area and Population
As the population increases daily, the cost of public works also rises. For example, expanding cities require more infrastructure such as roads, schools, and hospitals to accommodate the growing population.
Increase in State Functions
With modernization, the scope of public functions expands, leading to higher costs. For instance, governments now provide more services such as healthcare, education, and social welfare programs that were not as extensive in the past.
Rising Cost of Public Services
Inflation drives up the cost of goods and services, which in turn increases public expenditure. For example, rising prices for construction materials and labor can significantly increase the cost of public infrastructure projects.
Increase in National Wealth
As national wealth grows, including resources like minerals and forests, the government must manage and develop these resources. This includes arranging training programs for human resources, which increases public expenditure. For instance, mining activities may require significant investment in workforce training and safety measures.
Ability to Tax
The government’s budgetary function depends on its ability to tax the population. A higher ability to tax allows the government to adopt a larger budget for public functions. For example, a country with a robust tax system can afford more extensive social programs and public services.
War and Prevention of War
Modern countries allocate significant portions of their budgets for defense, including both war efforts and preventative measures. For example, maintaining a capable military force and investing in defense technology require substantial public funds.
Provision of Public Utility Services
Governments need to create utilities such as infrastructure for communication and transportation. For example, building and maintaining highways, bridges, and public transit systems are costly but necessary for economic growth and public convenience.
Expansion in Social Services
Governments must provide social security measures like old-age allowances and unemployment benefits. For instance, programs such as Social Security in the United States or universal healthcare in countries like Canada significantly contribute to public expenditure.
Technological Change
To support technological advancement, governments provide subsidies to make technology affordable for the public. For example, subsidies for renewable energy technologies help promote their adoption but increase public spending.
Expansion of the Public Sector
The public sector is expanding compared to the past, leading to higher costs for public services. For instance, more government agencies and public enterprises mean higher administrative and operational expenses.
Defective Financial and Civil Administration
Corruption and inefficient administration lead to increased costs for public services. For example, mismanagement and fraud in public projects can result in financial losses and higher-than-necessary expenditures.
Political and Social Factors
In many third-world countries, political unrest and social disorder require significant government spending to maintain order and provide services. For example, expenditures on law enforcement and emergency response during periods of instability can be substantial.
Requirement of Full Employment
To achieve full employment, governments invest heavily in job creation programs. For instance, public works programs designed to reduce unemployment involve significant expenditure on infrastructure projects and public services.
Economic Development
Governments undertake various large-scale development projects to spur economic growth, leading to increased public expenditure. For example, building new industrial parks, upgrading transportation networks, and investing in education and healthcare infrastructure are costly but essential for economic progress.
Public Revenue
There are two major sources of public revenue. They are as follows:
- Tax revenue: Taylor defined tax as follows: “Taxes are compulsory payments to the government without the expectation of a direct return in benefit to the taxpayer.” In developed countries, 80-90% of revenue comes from this source, and in developing countries, 60-70% of revenue comes from this source. It is of two types:
- a. Direct tax: Direct taxes are those which are paid and borne by the same person. For example, income tax.
- b. Indirect tax: Indirect taxes are those which can be shifted to another person. For example, commodity tax, customs duty, etc. If a tax is imposed on sugar, the dealer who first pays it charges it from the next buyer, and ultimately it is borne by the consumers of sugar.
- Non-tax revenue:
- a. Commercial revenue: Postal ticket selling, transport ticket selling (like train, steamer, etc.), bills of telephone, water, gas, etc. These are examples of commercial revenue.
- b. Administrative revenue: Fees, licenses, fines, etc.
- c. Grants and gifts: Grants and gifts from domestic sources and abroad.
- d. Special assessment: Extra revenue collected from cities and urban areas.
- e. Public property: Forests, mines are government property and generate income from these sources.
- f. Others: Foreign grants/assistance, prizes, voluntary grants of the people.