UNIT 8 PUBLIC FINANCE

Meaning: Public finance is the study of the role of the government in the
economy. It is the branch of economics that assesses the government
revenue and government expenditure of the public authorities and the
adjustment of one or the other to achieve desirable effects and avoid
undesirable ones.
Definition: According to Adam Smith “public finance is an investigation
into the nature and principles of the state revenue and expenditure”.
According to Hugh Dalton “Public finance is concerned with the income
and expenditure of public authorities ,and with the adjustment of the
one to the other.
The concepts of public finance
Public expenditure: wages and salaries; subsidies and transfers;
expenditure on goods and services such as infrastructures like road,
electricity, telecom, and human capital accumulation like health and
education; interest expenditure etc.
Public Revenue: Different sources of government revenue with major
focus on tax revenue.
Public Debt: Often public revenue falls short of expenditure and the
government has to borrow from internal and external sources.
Private finance (individual) Public finance ( government)
A private individual tries to have a The public authority adjusts its
surplus of income over income to its expenditure.
expenditure i.e. surplus budget
A private individual tries to have a A public authority will spend all
surplus of income over that it gets
expenditure i.e. surplus budget.
An individual can borrow money A public authority esp a state can
from other individual only and raised loans from both internally
externally
Finances of individuals are limited Finances of government are
 flexible
Private individuals cannot use The government can use coercive
force to get their income; they method to realize revenues
cannot compel others to get
income

Not a single individual can print A state can print currency notes in
notes order to meet its expenditure in
difficult times

2) Internal debt and External debt.

Points Internal Debt External Debt
1) Meaning When a government borrows When a government
from its citizens, banks, borrows from foreign
central bank, financial governments, foreign banks
institutions, business or institutions, international
houses etc. within the organizations like
country, it is known as International Monetary
internal debt. Fund, World Bank etc., it is
known as external debt.
2) Currency Use of domestic currency Use of foreign currency
3) Nature of Internal debt is less complex External debt is more
Management for management. complex for management.

3) Developmental expenditure and Non-Developmental expenditure.

Points Developmental Expenditure Non Developmental
Expenditure
1)Meaning The expenditure which The government expenditure
results in generation of which does not yield any
employment, increase in direct productive impact on
production, price stability the country is called
etc. is known as non-developmental
developmental expenditure. expenditure.
2) Examples Expenditure on health, Administration costs, war
education, industrial expenditure etc. These are
development, social welfare, unproductive in nature.
Research and Development
(R & D) etc.
4) Special assessment and Special levy.
Points Special Assessment Special Levy
1)Meaning The payment made by the citizens This is levied on those
of a particular locality in exchange
commodities, the
for certain special facilities given to
consumption of which is
them by the authorities is known harmful to the health
as ‘special assessment.’ and well-being of the
citizens.
2) Local bodies can levy a special tax Duties levied on wine,
Examples on the residents of a particular opium and other
area where extra/special facilities intoxicants.
of roads, energy, water supply etc.
are provided.

Direct Tax and Indirect tax.

Points Direct Tax Indirect Tax
1)Meaning Direct tax is paid by an An individual pays indirect
individual directly to the tax to the government but
government. A taxpayer cannot through an intermediary.
transfer this liability to another This intermediary then
entity or person. passes it on to the
government.
 2) Examples For example – personal income Goods and Services Tax
tax, wealth tax, etc. [GST]
3) Nature of Progressive tax, i.e., its rate Regressive tax, i.e., its rate
tax increases with taxpayer’s decreases with increase in
income. income.

1) Obligatory function is the only function of the Government.

Ans: No, I disagree with this statement.
Reason: a) Government is a formal or informal institution created by the
people in a specific region to perform various functions.
b) These functions of the government can be classified as Obligatory
functions and Optional functions
c) Protection from external attacks, maintaining internal law and order,
etc. are obligatory functions of
the government.
d) Provision of education and health services, provision of social security
like pensions and other welfare
measures, etc. are optional functions of the government.
Hence, Obligatory function is the only function of the Government.
2) Fines and penalties are a major source of revenue for the
Government.
Ans: No, I disagree with this statement.
Reason: a) The government imposes fines and penalties on those who
violate the laws of the country.
b) The objective of the imposition of fines and penalties is not to earn
income, but to discourage the
citizens from violating the laws framed by the Government.
c) For example, fines for violating traffic rules. However, the income from
this source is small.
d) Therefore, Fines and penalties are not a major source of revenue for
the Government.
3) The goods and services tax (GST) has replaced almost all indirect
taxes in India.
Ans: Yes, I agree with this statement.
Reason: a) The Goods and Services Tax [GST] came into effect in India on
July 1, 2017.
b) GST is different from an excise or sales tax imposed as a single-stage
levy on the manufacture or sale of a product.
c) It is a comprehensive tax base with nationwide coverage of goods and
services.
d) Hence, The goods and services tax (GST) has replaced almost all
indirect taxes in India.
4) Democratic Governments do not lead to an increase in public
expenditure.
Ans: No, I disagree with this statement.
Reason: a) Public expenditure is that expenditure that is incurred by the
public authority for the protection of their citizens, for satisfying their
collective needs, and for promoting their economic and social welfare.
b) Majority of the countries in the world are democratic in nature.
c) A democratic form of government is expensive due to regular elections
and other such activities.
d) This results in an increase in the total expenditure of the government.
e) Hence, Democratic Governments lead to an increase in public
expenditure.
5) Public finance is more elastic than private finance.
Ans: Yes, I agree with this statement.
Reason: a) Public finance refers to the income and expenditure of public
authorities, whereas, private finance is the income and expenditure of
individuals and private sector organizations.
b) The main objective of public finance is to offer a maximum social
advantage, while the main motive of private finance is to fulfill private
interests.
c) Public finance is more elastic compare to private finance because
credit provision is much more in the market to increase public finance
but, credit availability is limited to increase private finance.
d) Thus, Public finance is more elastic than private finance.
Non-tax sources of revenue of the Government.
Public revenue received by the government administration, public
enterprises, gifts, and grants, etc. are called as non-tax revenue. These
sources are different than the taxes. Brief information about these
sources are as follows
1) Fees:A tax is paid compulsorily without any return service whereas, a
fees is paid in return for certain specific services rendered by the
government. For example- education fees, registration fees, etc.
2) Prices of public goods and services:Modern governments sell
various types of commodities and services to the citizens. A price is a
payment made by the citizens to the government for the goods and
services sold to them. For example- railway fares, postal charges, etc.
3) Special Assessment:The payment made by the citizens of a particular
locality in exchange for certain special facilities given to them by the
authorities is known as ‘special assessment.’ For example- local bodies
can levy a special tax on the residents of a particular area where extra/
special facilities of roads, energy, water supply etc. are provided.
4) Fines and Penalties: The government imposes fines and penalties on
those who violate the laws of the country. The objective of the imposition
of fines and penalties is not to earn income, but to discourage the
citizens from violating the laws framed by the Government. For example,
fines for violating traffic rules. However, the income from this source is
small.
5) Gifts, Grants, and Donations: The government may also earn some
income in the form of gifts by the citizens and others. The government
may also receive grants from foreign governments and institutions for
general and specific purposes. Foreign aid has become an important
source of development finance for a developing country like India.
6) Special levies:This is levied on those commodities, the consumption
of which is harmful to the health and well-being of the citizens. Like fines
and penalties, the objective is not to earn income, but to discourage the
consumption of harmful commodities by the citizens. For example-
duties levied on wine, opium, and other intoxicants.
7) Borrowings: The government can borrow from the people in the form
of deposits, bonds, etc. It also gets loans from foreign governments and
organizations such as IMF, World Bank, etc. Loans are becoming more
and more popular source of revenue for governments in modern times.
Various reasons for the growth of public expenditure.
1) Increase in the Activities of the Government: The modern
government performs many functions such as the spread of education,
public health, public works, public recreation, social welfare schemes,
etc. It is observed that new functions are continuously being undertaken
and old functions are being performed more efficiently on a large scale by
the government. This leads to an increase in public expenditure.
2) Rapid Increase in Population: The population of developing countries
like India is increasing fast. In the 2011 Census, it was 121.02 crores. As
a result, the government has to incur greater expenditure to fulfill the
needs of the increasing population.
3) Growing Urbanization: The spread of urbanization is a global
phenomenon of the day. This leads to an increase in the government
expenditure on water supply, roads, energy, schools and colleges, public
transport, sanitation, etc.
4) Increasing Defence Expenditure: In modern times, defense
expenditure of the government is increasing even in peacetime due to
unstable and hostile international relationships.
5) Spread of Democracy: The majority of the countries in the world are
democratic in nature. A democratic form of government is expensive due
to regular elections and other such activities. This results in an increase
in the total expenditure of the government.
6) Inflation: Just like a private individual, the government has to buy
goods and services from the market for the spread of economic and social
development. Normally, prices show a rising trend. Due to this, the
government has to incur increasing costs.
7) Industrial Development: Industrial development leads to an increase
in production, employment, and overall growth in the economy. Hence,
the government makes huge efforts for implementing various schemes
and programmes for industrial development. This results in an increase
in government expenditure.
8) Disaster Management: Many natural and man-made calamities like
earthquakes, floods, cyclones, social unrest, etc. are occurring more
frequently. The government has to spend a huge amount on disaster
management which increases total expenditure. Modern governments are
working for the ‘welfare state’. Hence, there is a continuous increase in
public expenditure.
The types and importance of the Government budget.
 The budgetary provisions of public expenditure and revenue need
to be at different levels as per the changing needs of the economy.
Accordingly, the Government budget is of three types :
1) Balanced Budget: The government budget is said to be balanced
when the estimated revenue and expenditure of the government are
equal. That is, Government Receipts = Government Expenditure.
2) Surplus Budget: The government budget is said to be surplus when
estimated Government receipts are more than the estimated Government
expenditure. i.e. anticipated Government Receipts > estimated
Government Expenditure.
3) Deficit Budget: The government budget is said to be a deficit when
anticipated Government receipts are less than the estimated Government
expenditure. That is, anticipated Government Receipts < estimated
Government expenditure.
Importance of Government Budget:
a) Union Budget is important because it affects people and the economy
in general in a number of ways.
b) Taxes are the most interesting part of any budget. Taxes determine the
fate of businesses and individuals. The level of disposable income of the
taxpayers depends on the tax rates presented in the budget.
c) Government expenditure on various heads such as defence,
administration, infrastructure, education, and health care, etc. affects
the lives of the citizens and overall economy.
d) Budget is important because Governments use it as a medium for
implementing economic policies in the country.
e) Budgetary actions of the Government affect production, size, and
distribution of income and utilization of human and material resources
of the country.