INTRODUCTION TO PUBLIC FINANCE

Nature of public finance

Public finance is the study of how the government collects and spends revenue and
real resources. Its the field of economics concerned with how the government raises
money, how that money is spent, and the effects of these activities on the economy
and on the society.
Public finance studies how the governments at all levels- national, state and local
provide the public with desired services and how they secure the financial resources to
pay for these services.
Why public finance?
The importance of public finance could be view from the following angle.
1. Taxation: The consumption of cigarette, alcohol and other commodities that
fall within that general category need to be discouraged. The governments often
levy taxes to discourage the consumption of these harmful commodities.
2. Protection of Infant Industries: If the infant and newly started firm or
industries in developing nations are allowed to struggle with foreign firms
especially from those technologically advanced countries, they may not survive
due to many reason and factors. These industries need protection and
government often levies duties in order to protect them.
3. Provision Public Goods: Governments provide public good, the government-
financed items and services such as roads, military forces, lighthouses, and
streetlights. Private Citizens even the wealthy ones would not voluntarily pay
for these services, and therefore businesses have no incentive to produce them.
4. Side Effects of a Market Economy: Public finance also enables governments to
correct or offset undesirable side effects of a market economy. These side
effects are called spillovers or externalities. Example: households and
industries may generate pollution and release it into the environment without
considering the adverse effect pollution has on others. Pollution is a spillover
because it affects people who are not responsible for it. To correct a spillover,
governments can encourage or restrict certain activities. For example,
governments can sponsor recycling programs to encourage less pollution, pass
laws that restrict pollution, or impose charges or taxes on activities that cause
pollution.
5. Redistribute of Income and equity: Governments redistribute income by
collecting taxes from their wealthier citizens to provide resources for their
needy ones, and in this way the government reduces the inequality of income
and wealth within the economy. When government impose progressive taxes
on the richer members of the society and provides various facilities such as
subsided food, housing, free medical aid and education to the less privilege
members of the society, that is what is called equity.
6. Subsidies and grants: In modern times, subsidies and grants are inevitable for
producing essential goods and services meant for the masses. It has a prominent
place in the governmental expenditure of developing countries.
7. Optimum utilization of resources: The natural resources in developing
countries are underutilized. The proper utilization of natural resources is
imperative not only for the present generation, but also for the unborn
generations. The state can direct the flow of production, consumption and
distribution in the economy by framing a suitable budget policy.
8. Economic planning: Government usually have rolling plans for more than a
year, a times the implementation of say five year plan tends to require a huge
fund. Thus, government needs to combine resources, taxation and public
borrowing effectively.
9. Providing employment opportunities: The government has to spend huge
amount of public expenditure to provide the purchasing power to the general
masses and reduce the problem of unemployment in the economy.
10. Market Failures: These are the market inadequacies or private sector of the
economy fails to address and fail to satisfy all the needs of the society. Often
market fails in providing the societys desired set of goods and services and the
distribution of income and poverty. It also fails in achieving stability in
employment and prices.
Division of public finance
Public finance is divided into four dominions namely;
1. Government revenue
2. Government expenditure
3. National budget
4. Public debt
Private sector and public sector
The private sector is the one in which all production and consumption is in private
hands. It is composed of millions of separate households and firms, each making
choices that affects both the individual and society welfare. The public sector on the
other hand refers to all production and consumption in the public hands. It provides
public goods and services to the society.
The public sector differs from private sector in the following aspects
1. Government exists as a mechanism for making collective choices
2. Government choices are generally made by a small group of representative or
government employees
3. Government choices are made for the collective interests of the society
Composition of public sector
Public sector includes all production and consumption of goods and services such as
public schools, libraries, national parks, public playgrounds, bridges and roads by the
government and all government operated institutions. Public sector includes
1. Central government authorities
2. Local authorities
3. Parastatal organizations
Economic functions of the government
There are three major economic functions of the government, and they include;
1. Allocation function
2. Distribution function
3. Stabilization function
1. Allocation Function
This function concerns the role of the government in ensuring the efficient allocation
of public resources. It should be noted that the government has to provide for public
goods, and public goods such as national defense, street lights, public parks, law
enforcement and so on are different from private goods (remember the attributes of
non-rivalry and non-excludability); and since such goods cannot be provided through
market mechanism but are essential for consumers the government has therefore to
provide for them, and since the government has to provide for the state should ensure
efficient allocation of resources between private goods and public goods.
2. Distribution Function
Distribution function of the government concerns the role of the government in
ensuring social welfare and equity. This is achieved through tax and expenditure
policy of which the government affects distribution of personal income in a manner
which is just and fair. As such it taxes the rich and spends for the schemes which
benefit more the poor.
3. Stabilization Function
Stabilization function of the government concerns the role of the government in
designing and implementing macroeconomics policies. Economy of a country is
affected by economic fluctuations such as conditions of boom and depression,
inflation and deflations, unemployment level and so on. Such changes benefit some
and harm others. In such a situation appropriate policy measures are required by the
government to affect the levels of aggregate demand. Such measures are called
stabilization measures. These measures aim at avoiding such situations.
General functions of the government
The government performs the following functions which necessitates it to have fund
1. Administrative functions
This is the day to day running of the government through the established structures in
the civil services
2. Protection functions
In which the governments needs funds to maintain peace and security
3. Social functions
In this function the government needs funds to provide social services such as
education, water services and health facilities
4. Development functions
In this function the government needs funds to finance various development projects
such as roads, railways, research, irrigation and electricity.
Objectives of the government
Objectives of any government are to achieve the following;
1. To create full employment
In this function the government makes sure that all resources including human and
non-human resources are fully employed
2. Control inflation
Inflation has adverse effects on the economy; therefore its the responsibility of the
government to put it under control
3. To achieve economic growth
Any government must ensure that the economy grows at the desired rat
4. To raise living standard
Any government must ensure that the standard of living of its citizens are improved
5. To have a balanced of payment
A government ensures that its balance of payment is neither in deficit nor in surpluses
because both have negative effects to the economy
6. To achieve social and political stability
Any government must ensure that law and order are maintained in a country