Meaning & Scope of Public Finance
Meaning of Public Finance
The word public refers to general people and the word finance
means resources. So public finance means resources of the masses, how they are
collected and utilized. Thus, Public Finance is the branch of economics that
studies the taxing and spending activities of government. The discipline of
public finance describes and analyses government services, subsidies and
welfare payments, and the methods by which the expenditures to these ends are
covered through taxation, borrowing, foreign aid and the creation of money.
Definition
According to Findlay Shirras
“Public finance is the study of principles underlying the spending
and raising of funds by public authorities”.
According to H.L Lutz
“Public finance deals with the provision, custody and disbursement
of resources needed for conduct of public or government function.”
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.
Nature of Public Finance
Nature of public finance implies whether it is a science or art or both.
Public Finance as Science
Science is the systematic study of any subject which studies
relationship between facts. Public finance has been held as science which deals
with the income and expenditure of the government’s finance.It studies the
relationship between facts relating to revenue and expenditure of the
government.
Arguments in support of Public Finance as Science:
- Public
finance is systematic study of the facts and principles relating to
government expenditure and revenue.
- Principles
of Public finance are empirical.
- Public
finance is studied by the use of scientific methods.
- Public
finance is concerned with definite and limited field of human knowledge.
Public Finance as Art
Art is application of knowledge for achieving definite objectives.
Fiscal Policy which is an important instrument of public finance makes use of
the knowledge of government’s revenue and expenditure to achieve the objectives
of full employment, economic development and equality. Price stability etc. To
achieve the goal of economic equality taxes are levied which are likely to be
opposed. Therefore it is important to plan their timing and volume. The process
of levying tax is therefore an art. Study of Public finance is helpful in
solving many practical problems. Public finance is therefore an art also.
From the above discussion it can be concluded that public finance
is both science and art. It is positive science as well as normative science.
It is a positive science as by the study of public finance factual
information about the problems of government’s revenue and expenditure can be
known. It also offers suggestions in this respect.
It is also normative science as study of public finance presents norms or standards of
the government’s financial operations . It reveals what should be the quantum
of taxes,kind of taxes and on what items less of public expenditure can be
incurred.
Scope of Public Finance
Public finance not only includes the income and expenditure of the
government but also the sources of income and the way of expenditure of various
government corporations, public companies and quasi government ventures. Thus
the scope of public finance extends to the study of independent bodies acting
under the government’s direct and indirect control. The Scope of public finance
includes:
1. Public Revenue
Public finance deals with all those sources or methods through
which a government earns revenue. It studies the principles of taxation,
methods of raising revenue, classification of revenue, deficit financing etc.
Public expenditure studies how the government distributes the
resources for the fulfillment of various expenses. It also studies principles
that the government should keep in view while allocating resources to various
sectors and effects of such expenditure.
3. Public debt
It deals with borrowing by the government from internal and
external sources. AT any time government may exceed its revenue. To meet the
deficit, government raises loans. The study of public fiancé focuses on the
problems of raising loans and the methods of repayment of loans.
4. Financial/Fiscal administration
The scope of financial administration is wider. It covers all the
financial functions of the government. It includes drafting and sanctioning of
the budget, auditing of the budget, etc. Financial administration is concerned
with the organization and functioning of the government machinery responsible
for performing the various financial functions of the state. The budget is the
master financial plan of the government.
5. Economic Stabilization and Growth
In the present times, public finance is mainly concerned with the
economic stability and other related problems of a country. For the attainment
of these objectives, the government formulates its fiscal policy comprising of
various fiscal instruments directed towards the economic stability of the
nation.
6. Federal Finance
Distribution of the sources of income and expenditure between the
central and the state governments in the federal system of government is also
studied as the subject matter of the public finance. This branch of public
finance is popularly known as Federal Finance.
It is a positive science as by the study of public finance factual
information about the problems of government’s revenue and expenditure can be
known. It also offers suggestions in this respect.
It is also normative science as study of public finance presents norms or standards of
the government’s financial operations . It reveals what should be the quantum
of taxes,kind of taxes and on what items less of public expenditure can be incurred.
Principle of Maximum Social Advantage
The ‘Principle of Maximum Social Advantage’ was introduced by
British economist Hugh Dalton. Public Finance” is concerned with income &
expenditure of public authorities and with the adjustment of one with the
other.
Budgetary activities of the government results in transfer of
purchasing power from some individuals to others. Taxation causes transfer of
purchasing power from tax payers to the public authorities, while public
expenditure results in transfers back from the public authorities to some
individuals, therefore financial operations of the government cause ‘Sacrifice
or Disutility’ on one hand and ‘Benefits or Utility’ on the other.
This results in changes in pattern of production, consumption
& distribution of income and wealth. So it is important to know whether
those changes are socially advantageous or not.
If they are socially advantageous, then the financial operations
are justified otherwise not. According to Dalton, the principle of maximum social
advantage is the most fundamental principle lying at the root of public
finance. Hence, the best system of public finance is that which secures the
maximum social advantage from its fiscal operations.
Assumptions
The principle of social maximum advantage is based on the
following assumptions.
1. Taxes are the major source of government revenue.
2. The law of diminishing marginal social advantage applies to the
public expenditure.
3. The taxes are subject to increasing marginal social Disutility.
Conditions of Maximum Social Advantage
The main conditions of maximum Social Advantage are as follows:
1. The social benefit from the rupee spent(MSB) on public expenditure
should be equal to the sacrifice(MSS) from the last rupee collected by way of a
tax.It implies that MSB=MSS.
2. Public expenditure should be so distributed among various schemes
that benefit of last rupee spent on every scheme should be equal.
3. Taxations should be levied in different directions such that
scarify or disutility from last rupee collected from every direction should be
equal.
Explanation
Government collects revenue in the form of taxes and o transfers
that revenue to the public in the form of public expenditure. The sacrifice
that society has to make by paying taxes, is called social sacrifice. Similarly,
the gains which society makes by government expenditure on healthcare
,education etc. is called social satisfaction or Benefit. The government should
strike a balance between the public revenue and public expenditure in such a
way as could yield maximum satisfaction. This depends upon the Diminishing
Marginal Utility and Equi-Marginal Utility. The maximum satisfaction is
achieved when Marginal Social Sacrifice(MSS) due to taxation become equal to
Marginal Social Benefit(MSB) due to expenditure. Thus Maximum Social advantage
is obtained when,
MSS=MSB
MSS-Marginal Social Sacrifice
MSB-Marginal Social Benefit
i. Marginal Social Sacrifice
When a tax is levied, people have to part with their money to give
a segment of their money in the form of taxes. This causes monetary sacrifice. This
results in reduction of purchasing power of people. The MSS curve indicates the
rising marginal social sacrifice with every increase in the taxes.
When the government undertakes public expenditure, the society gets
utility or benefits. But as more and more benefits are provided to the people, its
utility to them goes on diminishing. The MSB curve shows diminishing marginal
social benefit. When the public expenditure increases from OM to OM1 the
marginal social benefit decline from LM to L1M1.
iii. Maximum Social Advantage
Dalton’s Conditions of Maximum Social Advantage
According to Dalton, ”Public expenditure in every direction shall
be carries out just so far that the advantage to the community is just
counter-balanced by the disadvantage of a corresponding small increase in
taxations.”
The doctrine of maximum social benefit can be explained with the
help of following figure:
MSS curve is showing marginal social sacrifice. It slopes upwards
from left to right side. This means that as a result of every increase in
government expenditure, an increase in marginal social sacrifice takes place. In
this diagram, point P is showing the position of maximum social advantage. At
this point, government expenditure becomes equal to the government revenue as
shown by ON. Further, MSS (Marginal Social Sacrifice) is equal to MSB (Marginal
Social Benefit), as shown by OM. Point P shows the positions of equilibrium.
If the government imposes the taxes which exceed ON, as shown by
ON1 marginal social sacrifice will be greater than marginal social
benefit(MSS>MSB).It will result into less social advantage. Similarly, if
the government keeps its expenditure less than ON1 as shown by ON2 marginal
social benefit will be greater than marginal social sacrifice, yet the aggregate
welfare of the society will be less.
Significance of Principle of Maximum Social Advantage
The practical significance of this doctrine depends upon how
social welfare is to be measured. Only after determining it, we can make an
estimate about the system giving maximum social benefit. Dalton has given
following standards of measurement in this regard:
Increase in production
Maximum social benefit depends upon what effect public finance is
making on the country’s production. In order to maximize the social benefit, such
changes in the revenue and expenditure of the government should be made which
could stimulate production and could increase employment and exports. According
to Dalton, increase in
production depends on three factors:
1. Such improvements are made in the production technique as
result of which production per workers goes up
2. Such improvements should be made in the production organization by
which the minimum wastage of economic resources takes place.
3. The nature of production should be improved so as to yield maximum
benefit to the society.
Equitable Distribution of Wealth
Maximum social benefit also depends upon the fact that there is a
proper distribution of income in society. For it, the taxation process should
be changed in such a way that more and more wealth is collected from the rich
and the same is spent on providing more and more facilities to the poor.
Political stability
Social welfare and production efficiency are promoted when there
is peance and order within and the country is protected against any external
aggression.
Economic Stability
By pursuing an appropriate Fiscal Policy, Government should avoid
economic fluctuations which is a pre-condition to achieve social welfare.
Full Employment
Every government aims at achieving the goal of full employment
through its fiscal policy. Full employment maximizes production and social
welfare.
Future Consideration
It is the bounden duty of the government to safeguard the
interests of the future generation also while utilizing the available natural
resources in the present.
Limitations
Difficulty of Measuring Sacrifice and Benefits
Maximum advantage is determined by marginal social sacrifice and marginal
social benefit or satisfaction. But measurement of both of them is very
difficult. Since society is a group of number of people, so it is not easy to
measure the sacrifice and satisfaction of everyone. Besides it, utility or
satisfaction is subjective .It is not possible to measure it.
Future Advantage
The expenditure made on the development projects yields several
benefits in future, but the public is burdened with taxes in the present. Therefore,
it becomes difficult to make an estimated of the maximum social advantage on
the bias of future advantages and present sacrifices.
Methodological inconsistency
To some economists, the disutility created by taxation to the
taxpayer is a micro matter concerned with individuals, while the utility of
public expenditure available to the society as a whole is a macro problem. Therefore,
serious mythological inconsistency is involved in balancing microeconomics
matter with macroeconomic matter.
Unrealistic assumptions
It is unrealistic to assume that government expenditure is always
beneficial and that every tax is a burden to society. For example, taxes on
cigarettes or alcohol can provide benefit to society, whereas a tax on
education of essential commodities may harm general interest of society,
similarly, expenditure on social overheads like health care will give rise to
social benefit whereas unnecessary increase in expenditure on defense may
divert resource from productive activities causing loss of welfare to society.
Misuse of government funds
The principle of Maximum social advantage is based on the
assumption that the government funds are utilized in the most effective manner
to generate marginal social benefit. However, quite often a large share of
government funds is misused for unproductive purposes which do not provide any
social benefit. Secondly, there is rampant corruption in government
departments. The funds meant for public expenditure are often misappropriated,
and therefore, the funds generated by way of taxation fails to generate social
benefit.
Large budget size
The financial operations of the government involve collection of
large sums of money from taxation and other sources and the disbursement of
large amounts by way of public expenditure. The effects of small additional
amounts of these on the community are difficult to measure. Therefore, in
practice, the public authorities are not in a position to estimate the marginal
benefits and the marginal sacrifices. It is almost impossible to determine the
particular size of budget that will maximize the welfare of the community.
Neglect non-tax revenue
The principle says that the entire public expenditure is financed
by taxation. But, in practice, a significant portion of public expenditure is
also financed by other sources like public borrowing, profits from public
sector enterprises, imposition of fees, penalties etc. Dalton fails to take
into account all such other sources.
Difficult to assess the capacity of the people
It is very difficult to measure the capacity of the people of a
state which they can afford to apply to the government. What people of a
country afford, depends upon:
1. The manner in which the money is raised
2. The manner in which the money is spent.
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