NATURE AND SCOPE OF PUBLIC FINANCE
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NATURE AND SCOPE Of PUBLIC FINANCE
Meaning
of Public Finance
The term
public Finance is a combination of two words: public and finance.
Therefore,
to understand the meaning of public finance, it is necessary to have some
knowledge of these two words. The word
‘public’ is a collective term for individuals living within an administrative
territory. It is used to signify the
government or the state, which represents the public. The word ‘finance’ implies
income and expenditure of the government.
Hence, public finance can be defined as the science of income and
expenditure of all levels of government, whether it is central government,
state government or local government. It studies through what sources the
government gets revenue, how it spends for promoting public welfare and how it
controls and administers income and expenditure. Thus public finance is a
branch of economics which deals with revenues and expenditures of the
government and with administration of revenues and expenditures.
The classical economists
with their faith in laissez-faire and market mechanism advocated minimum interference of the state in economic
activity. They believed that the market forces of demand and supply, which
would act as an invisible hand, guided all economic decisions. The invisible
hand of the market mechanism brings about automatic adjustment in the
allocation of resources in a competitive economy. They also believed that
supply creates its own demand and general overproduction and involuntary
unemployment is well neigh impossible and full employment and price stability
is supposed to reach automatically due to the operation of the market forces.
Hence the role of the state was not to interfere with operation of the market forces.
The activities of the state were tolerated only as a necessary evil and were to
be kept to the minimum possible scale. They believed that government is the
best government, which spends the least and imposes the least amount of taxes. Hence
a small budget was considered as the best budget. Thus under laissez faire
capitalism the government has to be just a witness of the economic game of
individuals by standing at the boundary of the pavilion. With this philosophy
in the background the scope of public finance was obviously very limited.
The subject of public
finance lacked a systematic discussion in the hands of the classical economists. Adam Smith’s well
known book ‘An Inquiry into the Nature
and Causes of Wealth of Nations’ deals with the ‘expenses of the
sovereign or the commonwealth’, “the sources of general or public revenue of
the society” and ‘ public debts’ David Ricardo in his book ‘Principles of Political Economy and Taxation’
published in 1817, devoted to the discussions of problems of taxation. He also
discussed the problems of public debt in his Essays on Funding System. J.S Mill in his well known work ‘Principles of Political Economy’
published in 1848,discussed at length the general principles of taxation,
classification of taxes into direct and indirect taxes, and problems of national debt. In short, the
classical economists recognized the importance of public finance and divided
the subject matter of public finance into government revenue, expenditure and
debt aspects, thereby limiting its scope and treating it as a positive science.
The Neo-classical economists also gave little significance to the discussions
of Public Finance. A systematic exposition of the whole subject of Public
Finance disappeared from the major works of Alfred Marshall and Edgeworth, the
two great economists of the 19th century.
However, it was
Charles.F. Bastable who first made an
attempt to make a systematic study of public finance. His book’ Public Finance’ published in 1892, was
exclusively devoted to the study of public finance . According to Bastable ‘Public
Finance deals with the income and expenditure of public authorities of the
state and their mutual relation as also with financial administration and
control’. This definition correctly emphasized the growing
importance of financial administration and control. Dalton in his book
‘Principles of Public Finance’ published in 1922, defined “Public Finance as one of those subjects that lie on the
borderline between Economics and Politics. It is concerned with the income and
expenditure of public authorities and with the adjustment of one to the other”.
The term ‘ public authorities’ refers to government or the state at all
levels, central, state and local. Dalton realized that public finance lie very
close to practical politics.
Philip E. Taylor said
that ‘Public Finance deals only with
the finances of the g public in an organized group under the institution
government. The finances of the government include raising and disbursement of
government funds. Public finance is concerned with the operations of the fisc
or public treasury. To the degree that it is a science, it is a fiscal science,
its policies are fiscal policies and its problems are fiscal problems”. Mrs.
Ursula Hicks states that the main
content of Public Finance consists of the examination and appraisal of the
methods by which governing bodies provide for collective satisfaction of wants
and secure the necessary funds to carry out the purpose. This
definition makes it clear that satisfaction of collective wants is the starting
point leading to secure necessary funds.
The above definitions of
public finance point out that public finance is concerned with revenue
expenditure process of the government and how the revenue expenditure process
is administered. It is only concerned with how the public authorities have
collected revenue and spent them for collective satisfaction of wants. It is
not concerned with how the revenue expenditure process is affecting the social
and economic aspects of the economy.. Thus the scope of public finance was
narrow and Public Finance was regarded only as a positive science
However, with the
appearance of the Great Depression in the thirties and the publication of J.M.
Keynes’s ‘General Theory of Employment Interest and Money’ in 1936, the influence
of the government fiscal operations on the overall level of economic activity
and the level of employment became an essential part of the study of Public
Finance. Modern Economists like Musgrave, Brownlee and Allen Rolph and Break
and Bernard.P.Herber and those following them therefore emphasized the
inclusion of the “ principles of public economy” in the scope of public
finance. Richard A. Musgrave observed that “ the complex problems that centre
around the revenue expenditure process of the government is referred to traditionally
as public finance.” while operations of public household involve money flows of
receipts and expenditures, the basic problems are not issues of finance; rather
they are problems of resource allocation, distribution of income, full
employment and price stability”. Brownlee and Allen says that “ It is with the public economy… with the effects of governmental money spending and money raising activities
upon the allocation of resources, distribution of income and general level of
economic activity within the economy that the bulk of our analysis is
concerned.
The study of effects
of fiscal operations is included in the scope of public finance.
Prof. Herber says “The government means of allocation is accomplished through
the budgetary practices of taxing and spending... in addition to allocation function
public finance is also concerned with three other major areas of economic
activity.- distribution, stabilization and economic growth.” Rolph and Break.
defined public finance as the discovery and appraisal of the effects of
government financial policies. Naturally the appraisal of the results achieved
involves value judgments. It means that effects of fiscal operations are
studied and analysed and it is seen whether they are good or bad. Thus, the above
definitions points out that scope of Public Finance has been widened by modern
economists and it can be said that Public Finance is also a normative Science.
The scope and subject matter of Public Finance
In the light of
above discussion the subject matter and scope of public finance may be summarized
as under:
Public
Revenue:
The income of
the state from all sources is referred to as public revenue. This part of
public finance deals with the several sources from which the state derives its
revenue. It discusses and analyses the comparative advantages of various
methods of raising revenue and the principles which should govern the choice
between them. Since taxation is the most important source of revenue for any
government, we study the different types of taxes, the canons of taxation, the
theories of taxation, the impact and incidence of taxation, the effects of
taxation, the problems of tax evasion and avoidance and its remedial
measures.
Public
Expenditure:
Modern state has
to perform various functions in order to maximize the welfare of the people.
These activities involve heavy public expenditure. This part of public finance,
studies the fundamental principles
governing the flow of government funds into different spending streams, the
method of incurring state funds on various items of expenditure, classification
and justification of public expenditure, canons of public expenditure, problems
relating to expenditure of public funds, the reasons for growth of public
expenditure, the theories explaining the growth of public expenditure, the
effects of public expenditure on the economic life of the country, the expenditure policies of the government
and the measures adopted for keeping a check on public expenditure.
3.Public
debt:
Public debt arises when the governments borrow when their expenditure
exceeds revenue. This branch of Public Finance studies causes of borrowing,
sources of public debt, classification of public debt, effects of public debt,
methods of debt redemption, and public debt management.
4.Financial
administration:
Financial administration is concerned with the study of different aspects
of public budget. Budget is the master financial plan of the government. The
whole procedure of preparation of the budget, presentation of the budget,
passing and execution of the budget, evaluation of the budget, all these
aspects fall into the subject matter of financial administration. In short,
financial administration studies the organizing and disbursing of the finances of
the state.
5.Economic
stabilization and growth:
This
part of public finance deal with the use of public revenue and public
expenditure to secure stability in prices by checking inflationary and
deflationary tendencies., full ,employment, optimum use of resources and equitable
distribution of income and wealth. The use of fiscal tools to achieve economic
stability has assumed much importance after the publication of Keynes’s
‘General Theory’.
In the case of less developed countries,
fiscal policy is used as a tool to stimulate economic growth. Hence, the main
consideration of financial administration is to frame and implement various
policies required for growth. The use of fiscal policy to stimulate economic
growth in less developed countries became significant after Second World War.
Federal Finance:
The
existence of multi-layer system of government necessitates a corresponding
division of functions and resources between different layers of government. The
principles of allocation of resources between different government, problems
relating to intergovernmental financial flows, financial adjustments made by
the central government to state governments etc. are studied in this part of
public finance.
According to
Prof. Richard A. Musgrave, The scope of public finance embraces
three functions of government budget policy. These three functions are :
Allocation
function,
Distribution
function
Stabilization
function.
Allocation
function refers to the allocation of resources by means of revenue and
expenditure policies for the satisfaction of public wants. Distribution
function is concerned with measures taken to bring about an equitable
distribution of income and wealth in the economy. Government redistributes
income by taxing the rich and spending on welfare programmers for the poor. Stabilisation
function is concerned with measures taken to maintain price stability and full
employment.. It means that the effects of fiscal operations on allocation of
resources, distribution of income , full employment and price stability and
growth are studied in the scope of
public finance.
The scope of public
finance is not just to study 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
Reasons for widening scope of public finance:
The scope of public
finance is not static, but dynamic in the sense that it is continuously
widening with the passage of time. Several factors have contributed to the
widening scope of public finance. They are:
1.Change
in the concept of the state:
The classical economists
with their faith in laissez-faire advocated minimum functions of the
government. Under the policy of laissez-faire, the state was regarded as a
police state, which was primarily interested in the protection of the citizens
from external aggression and maintaining law and order in the country. The
concept of the state and its functions gradually changed especially after the
global depression of the thirties. The publication of Keynes’s ‘General theory’
sounded the death knell of classical version of laissez-faire. Keynes
emphasized increased state participation in economic life. The concept of
police state has given place to welfare state. It is now universally agreed
that the object of the state is to maximize the welfare of the community as a
whole.
2.Increase in the activities of the state:
The change in the concept
of the state from police state to welfare state has extended its functions. It
has to make provision for medical facilities, housing, education, poor relief
sanitation and various other services of public utility so as to enhance the
welfare of the community. The modern state helps the people to raise their
productive power by constructing infrastructural facilities such as railways,
roads, power projects, post and telegraph etc. It takes steps in reducing
inequalities in the distribution of income and wealth, it controls the price of
essential commodities, it takes steps to counteract inflation and deflation. In
times of war it has to mobilize and control the entire resources of the nation
in order to face it successfully.
Governments of advanced
countries are responsible for maintaining the stability and expanding the level
of employment and bringing about the goal of full employment as far as
possible. In the case of developing countries the government is committed to
the programme of accelerated economic development. Thus it is obvious that the
functions of developed and developing countries are expanding with the increase
in responsibilities of the government. In order to discharge these increased
functions the state has to increase its expenditure. To meet the increased
expenditure it has to mobilize funds with the help of the methods laid down by
the science of public finance. Hence, the scope and importance of public
finance has expanded considerably in modern times with the increase in the functions of the state.
3.Influence of Keynes:
The publication of
Keynes’s ‘General Theory of Employment Interest and Money’ was a big blow to
the old classical economics, which was based on laissez faire. Keynes shattered
the basic foundations of the classical doctrine. He asserted that supply does
not create its own demand and full employment and price stability is not
supposed to reach automatically. According to Keynes in an advanced economy the
propensity to consume diminishes as income increases. In other words, the
propensity to save increases as income increases. Hence larger proportion of
additional income is saved and not spent. This tendency of less consumption and
larger savings results in lowering of demand for goods and services. Hence to
maintain income and employment at the current level, it is necessary to offset
the effects of declining private expenditure by a corresponding increase in
public expenditure directly by undertaking public works programs on a larger
scale. Thus Keynes showed clearly that the operations of public finance can be
used successfully to regulate aggregate demand and create conditions of full
employment and economic stability. Thus, due to the influence of Keynes the
scope of public finance has widened.
4.Changing problems of Economics:
In the thirties and
forties the problem was one of stabilization of the economy i.e. to get out
from a situation of unemployment and reaching a stage of full employment. Since
fifties attention has been shifted to the rate of growth of potential output
and inflation. After a high level of employment has been reached in, the problem became one of restraining
inflation without losing full employment at the same time. . Besides the
appearance of stagflation has raised doubts regarding the effectiveness of
traditional fiscal measures and called for a new approach.
5.Problems of economic development in under developed countries:
In under developed
countries the main objective is rapid economic development. Public finance can
accelerate economic development in many ways such as increasing the rate of
savings and investment, promoting economic stability, equal distribution of
income and wealth.
Nature of Public finance
Public finance is a
science. Science is a systematic study of any subject which studies the casual
relationship between facts. Public finance ia systematic study relating to
revenue and expenditure of the government. It also studies the casual relationship
between facts relating to revenue and expenditure of the government.
Public finance is an art
Art is the application of
knowledge for achieving definite objective. Fiscal policy which is an important
instrument of public finance makes use of the knowledge of revenue and
expenditure. To achieve the objective of economic equality, taxes are levied at
a progressive rate. The magnitude of development expenditure is enhanced to achieve economic development. Since every
tax is likely to be opposed, it becomes essential to plan their timing and
volume. The process of leving tax is certainly an art. Budget making is an
art in itself. Study of public finance
helps to solve many practical problems. Therefore Public finance is an art .It
is concerned with real problems.
Public finance is a positive as well as normative science
In its positive aspect,
the study of public finance is concerned with the revenue expenditure process
of the government. It was considered as a description of how public authorities collect revenue,
how they make expenditure and how the revenue expenditure process is
administered.. It deals with the facts as they are. It is not concerned with
the good and bad effects or with the welfare aspect of certain tax or
expenditure or the adverse effects of certain taxes or budgetary policies. The classical
economists regarded that public finance is a positive science. They neglected
the normative aspect of fiscal operations. It was argued that “ fiscal problem
pure and simple should not be confused with alien considerations of social and
economic policy”.
.
In its normative aspect it anlyses the effects
of fiscal operations on the overall level of economic activity. It is also
assessed to what extent they are good or bad. In its normative aspect norms or standards of
fiscal operations are laid down, investigated and appraised. The basic norm of
modern public finance is social welfare. In fact, it is the welfare aspect of
the subject which makes public finance a normative science. The
normative character of
public finance received emphasis from Keynes in
his General Theory. He pointed out that fiscal operations can be used to
influence the general level of economic activity. Governments all over the
world have been making use of fiscal devices to control
cyclical fluctuations, reduce inequality in the distribution of income and
wealth to achieve full employment and economic growth, prove the normative
aspect of the science of public finance
It is clear that public
finance is not only a study of the revenue
expenditure process, but also its effects on the economy as a whole.
Modern governments are not merely concerned with revenue raising and spending
exercise ,but also with the good and bad effects of every move
involved in that process. It means that the governments do exercise some
value judgements while taking up any step in matters related to taxation,
public expenditure,, borrowing and deficit financing as well as in the
satisfaction of social wants. Hence public finance is a positive as well as a
normative science. On
normative consideration, public finance becomes a skillful art, whereas in its
positive aspect, it remains a fiscal science.
Comparison
between public finance and private finance:
Public finance deals with
income and expenditure between of public authorities. It includes the policies
and methods employed to secure money to carry out its expenditure. whereas
private finance deals with the income and expenditure of an individual, private
company or business ventures. It includes the study of their own view regarding
expenditure and borrowing. A comparison between public finance and private
finance is not only necessary, but also
useful to understand and appreciate the nature of problems of these two
branches more correctly. There are
similarities as well as dissimilarities between private finance and public
finance.
Similarities:
1. Same objective:
Both the individual and
the state have the same objective i.e the satisfaction of human wants. Public
finance is concerned with the satisfaction of social or collective wants,
whereas private finance is concerned with the satisfaction of personal or
individual wants.
1.Maximum advantage
Both public and private finance try to secure maximum advantage or
satisfaction. A private individual tries to secure maximum gains from his
expenditure. Likewise the government also wishes to secure maximum social
advantage from its financial operations.
2.Borrowings
Borrowing
becomes essential both in public and private finance when current income fall
short of current expenditure. An individual borrows from different sources such
as relatives, friends and financial institutions .The state also borrows from
individuals and financial institutions. Besides both public and private finance
are required to repay the loans sooner or later.
3.Adjustment of income and
expenditure:
Since the resources at the disposal of the individuals and government are
limited compared to their needs, both public finance and private finance face
the problem of adjustment of income to expenditure.
4.Problem of choice:
Both public and private
finance face the problem of choice as both are concerned with unlimited ends
with scarce resources.
5.Contribution to national product:
The financial activities both the private sector and public sector helps
to increase savings, investment and production and thereby contributes to
national product
6.Efficient management
Private as well as public finance
needs efficient management and administration. In the event of collapse of an
efficient management, both are compelled to face dire consequences
Dissimilarities/Distinction
between public finance and private finance:
Public finance differs from private
finance in many respects. The major sources of difference are:
1.Adjustment of income and
expenditure:
An individual adjusts his expenditure to his income, while public
authorities adjust their income to expenditure. An individual first calculates
his income and then determines his expenditure. Public authorities on the other
hand first determines the volume their expenditure and then devise ways and
means to raise necessary revenue to meet the expenditure. The individual cuts
the coat according to his cloth. But government decides the size of the coat
and tries to get the required cloth.The difference in adjustment of income and
expenditure arises because the individual ordinarily knows the size of his
income, while the government does not know its income.
2.Application of the principle of equi - marginal utility:
An individual is more capable of applying the principle of equi- marginal
utility to plan his expenditure than a government because he is more free to
follow his own scale of preferences. A public authority is supposed to have no
freedom in respect of expenditures such as defense, law and order, education,
poor relief etc.
3.Nature of resources:
The resources of an individual are more or less limited while that of a
public authority is enormous. Besides tax revenue the public authorities can
borrow from external sources and can resort to the method of deficit financing
to increase their income, but an individual can never do so. Public authorities
can also pass laws to take over profitable private business and trade in their
hands for the purpose of raising income.
4.Coercive methods:
The government can use compulsory methods to collect revenue. No
individual can refuse to pay taxes if he is liable to pay . But private
individuals and businessman cannot use force to get their income. Hence income
of public authorities is more assured than that of private individuals.
5.Motive
of Expenditure:
Motive behind private expenditure is profit, whereas government is
motivated by social welfare.
6.Nature of budget:
An individual generally believes in surplus budget and a deficit budget
is considered always undesirable. On the contrary government may find it useful
to have deficit budget for several years especially in times of war and
economic development.
7.Long
term considerations:
Private individuals
investments in those fields of business where returns are quick. They keep
in view short-term considerations. But government is influenced by long term
considerations as it is guardian of both
the present and future generation. Hence the government undertakes such
projects like construction of multipurpose river valley projects, soil
conservation Schemes, education, public health, aforestation etc.
8.Publicity
and audit:
Private individuals like to keep their financial transactions secret,
while government gives greatest publicity to its financial activities. e.g.
maximum publicity is given to the budget proposals and allocations of
resources to different heads in the five
year plan. Besides the accounts of the public authorities are subject to
compulsory audit and inspection, while it is always not mandatory for
individuals
9.Deliberation in expenditure:
The pattern of expenditure of an individual is governed by customs,
habits, status and personal needs. On the other hand pattern of public
expenditure is governed by deliberate economic policy of the government.
10.Compulsory character of
expenditure:
Certain expenditure of the public authorities
are compulsory in character. They cannot avoid or postpone.
certain
expenditure like defense, maintenance
of law and order, relief in times of natural calamities etc.
Findlay
Shirras says that compulsory character is an important feature of public
finance
11.Impact
of expenditure
An individual’s spending policy has very little impact on the society as
a whole. But the state can change the nature of the economy through its
fiscal policy. By following a deficit budget it can control depression.
Likewise it can fight inflation through a surplus budget
12.Budget
period:
There is no particular time period for individual plans. They plan
according to the time duration over which he earns his income. It may for
weekly wages, monthly income or annual profits. But the government prepares its
budget for one year.
References
1.
Hugh Dalton: Principles of Public Finance
2
Ursula Hicks :
Astudy in Public Finance
3
Richard A.Musgrave : TheTheory of Public Finance
4
Philip.E.Taylor :
Economics of Public Finance
5
Bernard.P.Herber:
Modern Public Finance
6
P.C.Jain :
Economics of Public Finance
7
S.N.Chand: Public
Finance
8
H.L.Bhatia :
Public Finance
9
.B.P.Tyagi.Public
Finance
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Thanks both of you.