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What is Public Finance?
Public finance refers to the study of the role of the government in an economy. This branch of economics especially considers government expenditure and government revenue of public authorities. The aim is to adjust expenditure and revenue to bring about a desirable change in the economy or avoid an undesirable one. That means public finance is the study of government’s expenditure and revenue with an aim to bring a positive change in the economy.
The role of the government in public finance can be discussed under the following three categories:
An efficient allocation of government resources
The distribution of income among the citizens
The stability of the economy
It is notable that the allocation of resources is usually done by the private markets and when the markets are efficient, there is either too little or no role of government in the allocation of resources. However, in most cases, private markets are not efficient enough which offers the opportunity and scope to governments to intervene in the process of allocation of resources.
The role of government in the economy becomes especially useful during market failures. Market failures may occur due to public goods, externalities, informational advantages, strong economies of scale, and network effects. Government failure refers to public provisions via voluntary or government associations that are subject to other inefficiencies.
Structure of Public Finance: Public Expenditure
Public expenditure is the expenditure or spending made by the government of a country for collective needs and wants. Public expenditure may be made for provisions such as a pension, education, healthcare, housing, security, infrastructure, etc.
Until the 19th century, the span of public expenditure was very limited as laissez-faire philosophies were followed which stated that money left in private hands could bring better returns. In the 20th century, however, famous economist John Maynard Keynes expanded the theories and the role of public expenditure in measuring the levels of income and distribution in the economy. Since then, public expenditures by governments have followed an increasing trend. The sources of government revenue are taxes and non-tax revenues.
If we go back to history, in the 17th and 18th centuries, government expenditure for public needs was considered a wastage of money. The popular belief was that the government should do its traditional functions of expenditure on defense and maintaining law and order.
The average public expenditure to Gross Domestic Product (GDP) ratio has shown an increasing trend. The only industrialized countries that reduced government expenditure significantly are New Zealand, Ireland, and Norway. One of the reasons for this is the growing scepticism and negativities arising out of governmental intervention in the economy.
Structure of Public Finance: Public Revenue
Public revenue can be divided into Tax Revenue and Non-Tax Revenues. Let us study more in detail below about the two.
Taxes: Taxes can be direct or indirect. Direct taxes are paid on the basis of the personal income and property of the taxpayer. The tax burden cannot be shifted to others in the case of direct taxes. Indirect taxes are paid for goods and services. Indirect taxes are paid during the sale or production of goods and services. Indirect taxes have the option of shifting the tax burden to others.
Non-tax revenue: Non-tax revenues are revenues collected by the government via options other than tax.
It includes the following classifications:
Fees − Fees are provided by citizens to the government for specific services. Examples include court fees, education fees, etc.
Prices of public goods and items − Governments sell various goods and services to the citizens for which citizens pay prices. Postal services, railway fares, etc.
Special Assessments − These are special provisions provided by governments to citizens for which a levy is collected. For example, governments may levy a special tax on water supply in an area.
Fines and penalties − Fines are collected for violating the laws. It is a measure to discourage citizens from violations of law and order.
Gifts, grants, and donations − The government may earn gifts from citizens. Moreover, grants and donations may also be made by local and foreign authorities.
For example, a US$ 1 billion grant to India by the World Bank to contain the Coronavirus pandemic.
Special levies − two
one − Special levies are attached to items that are harmful to health. Taxes on alcohol is an example of this.
Borrowings − The government can borrow money in the form of bank deposits and bonds etc.
Structure of Public Finance: Public Debt
Public debt is the total amount borrowed by the government to finance its development budget which includes total liabilities. Public debt also refers to the overall liabilities of central and state governments. However, the central government clearly separates its debt liabilities from the states.
The central government’s debt liabilities are broadly classified into two categories —
the first is the debt that must be paid to the Consolidated Fund of India, and
the other one is the public account.
The central government of India has followed a concentrated strategy to reduce its reliance on foreign loans in its overall loan mix. The internal debt of the central government now constitutes over 93% of the overall public debt. The internal loans that form the bulk of public debt are classified into two broad categories which are marketable and non-marketable debt.
The prominent sources for the collection of public debt include government securities (G-Secs), external assistance, treasury bills, and short-term borrowings.
According to the Reserve Bank of India Act, 1934, the RBI has the responsibility of both being public debt manager and a banker for the government. The RBI, therefore, handles all the money, foreign exchange, remittances, and banking transactions. The central government also deposits the cash balance with the RBI.
Public finance plays a key role in the growth of economies. In order to be sustainable and progressive, the public financing of a country must be efficient. As the government is responsible for public finance, it must act responsibly for a holistic public finance policy.
Public finance also results in the overall well-being of an economy. If the various components of public finance are placed structurally, the results of public finance administration may result in a resilient and well-structured economy. That is why public finance is so important.
Q1. What is fiscal policy? Is it related to public finance?
Ans. Fiscal policy is the use of government expenditure as well as tax policies to impact economic conditions, primarily macroeconomic conditions. The policy is related to aggregate demand for commodities and services, inflation, employment, and economic growth. Fiscal policy is a part of public finance.
Q2. What is financial administration? Is it linked to public finance?
Ans. financial administration refers to the procedure of performing daily, weekly, and monthly reconciliations. It is done to ensure proper booking of revenues at a district level. The disbursements are made on behalf of the District and the disbursement requests are transmitted to the authorities. Disbursement reports are provided to the district for formal approval of the Commissioners in a timely fashion. It links the district levels of administration with the central authorities in the public finance domain.
Q3. What are special levies? What is the aim of levying special levies?
Ans. Special levies are levies attached to items that are harmful to health. Taxes on alcohol is an example of this. The aim of special levies is to discourage users and to let them abstain from the consumption of items that are harmful to health.
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