INTRODUCTION
TO
PUBLIC
ADMINISTRATION/
MANAGEMENT
Course Code MGT 111
Lecture 26
- Concept of Public Finance
- The components of Public
Finance
- Distinction between Private and
Public Finance
Background
When we made the distinction
between public and private
sector we said that public goods
are non excludable whereas
private goods are excludable.
Example: You cannot exclude
one or group of people from the
use of one public good
Similarly public goods are non-
divisible and private goods are
divisible. E.g. parks, roads Vs.
motorbike
When goods are produced it
requires financing. The distinction
between public and private goods
and the concept of public sector
leads us to look into public
finance.
Public finance is related to the
financing of government
activities and can be defined as
a subject which discusses
financial operation of the fisc (or
public treasury)
Concept & Definition
‘Public finance deals with the
finance of the government. The
finances of the government
include the raising and
disbursement of government
fund’.
Carl Plehm says that the term
public finance is confined to the
study of funds raised by
government to meet the cost of
the government.
The subject matter of public
finance deals with not only the
way in which public treasury
operates, it also deals with the
repercussions of policies
adopted.
Musgrave calls the government
sector as ‘public household’. The
objective of this household are:
1. Allocation of resources: Market
failure
2. Distribution of income and
wealth: Tax transfer,
consumption tax
3. Stabilization of prices and
employment
Components of Public
Finance
It must be mentioned here that the
government operates at three
levels and the subject of public
finance looks into financial
problems and policies of
government at different levels and
studies inter governmental
financial relation.
The three levels of
government are:
1. Federal
2. Provincial and
3. Local
Following are the main
components of public finance:
1. Public revenue: sources of
government income are:
a. Taxation and its effect on
economy
b. Non-tax revenues such as fee,
fines, grants, interest receipt
etc.
c. Public debt problems: public
debt is a source of income
2. Public Expenditure: through
public expenditure government
participates and contributes to
the financial flows of the
economy. It is also a tool for
implementing welfare and other
policies.
3. Financial Administration: It
involves issues of financial
administration including public
budget, its approval,
implementation and audit.
Without the study of financial
administration the subject of
public finance remains
incomplete.
4. Federal finance: It studies the
multilayer system of government
which necessitates a division of
function and resources between
the layers of government and inter-
governmental relations.
Similarities &
Dissimilarities
Private finance means the financial
problems of individual economic
unit, a household, a shop, a firm
etc. Private does not form part of
government. We will look at the
similarities and dissimilarities to
develop analytical framework for
public finance.
Similarities
Modern economies are monetized.
That is, they create and use
financial claims. Both private and
public sectors are engaged in
activities that involve purchases,
sales and other transactions. They
are thus engaged in production,
exchange, savings, capital
investment and so on.
In order, to finance these
operations, the government
creates money (which is a
financial asset), raises loans,
makes payment, etc. Similarly,
private economic unit lends,
borrows, receive payments, make
payments, etc.
Both have limited resources at
their disposal and try to maximize
decisions. But the similarities are
few.
Dissimilarities
1. Private economic unit has to
live within its own means. Its
deficit budgeting can be only
for limited time period. It can
accumulate outstanding debt
liabilities up to a limit. But the
government can add to its
outstanding debt with every
budget.
2. It is not only the amount of
borrowings but also the forms,
interest and other terms that
government can decide.
Government can borrow both
internally and externally. The high
creditworthiness of government
enables it to borrow at lower rates.
3. The government can create
legal tender currency. That is it
has the power to add to currency
supply. There are formal technical
restriction to the supply of
money, that is how much
currency supply should be added,
but restriction can be waived if
the government so wants.
4. The private finance follows the
‘market principle’ or the principle
of economic rationality but the
public finance follows the ‘budget
principle’.
5. The government is expected
to take the long term and short
term view of the economy,
because society is perpetual
entity and for its welfare many
activities are needed which have
no immediate economic return.
6. The government has complete
power to raise money through
taxes, confiscation, borrowing and
printing notes; it has to use this
power carefully because over
borrowing by the government can
starve the private sector. Similarly
excessive taxation can discourage
Savings and investment.
What can be said about public
finance is that there are some
fundamental differences between
public and private finance. But it is
essential to remember that public
sector is part and parcel of the
total economy.
THE ECONOMIC
SYSTEM AND PUBLIC
FINANCE
The public sector is the important
sector and it can be operated in an
effective way to improve the
performance of economy.
The classical economist believed
that private sector was always
efficient because it responded to
the market signals.
The borrowing by the government
will lead to budget deficit and
interfere with economy. It was
said that government should
balance the budget.
CONCLUSIONS
Public finance deals with the financing
of the cost that government bears to
provide services
Public finance has four broad areas:
1. Revenue raising
2. Public Expenditure
3. Financial Administration
4. Federal Finance
Comparison of public and private
finance