Public Finance NotesIntroduction to Public FinanceFor B.Com/BBA/MBA (CBCS and Non CBCS Pattern)
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In
the post I have given a brief introduction to Public Finance. These notes are
useful for the students of B.Com and BA of various universities. For notes
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Table of
Contents |
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1. Meaning and Definition of Public Finance 2. Nature of Public Finance 3. Scope of Public Finance / Subject Matter
of Public Finance 4. Importance and Significance of Public
Finance 5. Role of Public Finance in developing
country like India 6. Public and Private Finance – Similarities
and Difference 7. Concept of Principle of Maximum Social
Advantage with criticism 8. Economic tests of social advantage as
suggested by Dr. Dalton 9. Various theories of Public Finance a) Classical Concept of Public finance b) Keynes’ theory of Public finance c) Taxation and Equitable Distribution 10. Relationship of public finance with
economics, politics, history, sociology, ethics, jurisprudence, psychology |
Meaning
and Definition of Public Finance
Public finance is a study of income and expenditure or receipt and
payment of government. It deals the income raised through revenue and
expenditure spend on the activities of the community and the terms ‘finance’ is
money resource i.e. coins. But public is collected name for individual within
an administrative territory and finance. On the other hand, it refers to income
and expenditure. Thus public finance in this manner can be said the science of
the income and expenditure of the government.
Different economists have defined public finance differently. Some
of the definitions are given below.
According to prof. Dalton “public finance is one of those subjects
that lie on the border lie between economics and politics. It is concerned with
income and expenditure of public authorities and with the mutual adjustment of
one another. The principal of public finance are the general principles, which
may be laid down with regard to these matters.
According to Adam Smith “public finance is an investigation into
the nature and principles of the state revenue and expenditure”
To sum up, public finance is the subject, which studies the income
and expenditure of the government. In simpler manner, public finance embodies
the study of collection of revenue and expenditure in the public interest for
the welfare of the country
Nature
of Public Finance
Nature of Public finance implies whether it is a science or art or
both.
a) Public Finance is a science: Science
is a systematic study of any subject which studies casual relationship between
facts. Public finance is a systematically study relating to revenue and
expenditure of the government. It also studies the casual relationship between
facts relating to revenue and expenditure of the government. Prot. Plehn has
advanced the following arguments in favour of public finance being science.
1) Public
finance is not a complete knowledge about human rather it is concerned with
definite and limited field of human knowledge.
2) Public
finance is a systematic study of the facts and principles relating to
government revenue and expenditure.
3) Scientific
methods are used to study public finance.
4) Principles
of public finance are empirical.
Science is of two types: (1) Positive science
and (2) Normative science. In positive science one knows about factual
situation or facts as they are. It describes “what is”. As against it,
normative science presents norms or ideals. It describes “what ought to be” or
what is right or wrong i.e. value judgement. By the study of public finance one
gets factual information about the problems of government’s revenue and
expenditure. Public finance is therefore, a positive science. Study of public
finance also reveals what should be the quantum of taxes. Which taxes, direct
or indirect, should be imposed. On what items more or on what items less of
public expenditure is incurred. Public finance is therefore a normative
science. Thus, study of public finance offers suggestions regarding revenue and
expenditure of the government as also apprises of their factual position.
b)
Public
Finance is an art: In the words of J.N. Keynes, ”Art is the
application of knowledge for achieving definite objectives.” Fiscal policy
which is an important instrument of public finance makes use of the knowledge
of the government’s revenue and expenditure to achieve the objectives of full
employment, economic equality , economic development and price stability, etc.
To achieve the objective of economic equality taxes are levied at progressive
rate. Since every tax is likely to be opposed, it becomes essential to plan
their timing and volume. The process of levying tax is certainly an art. Budget
making is an art in itself. Study of public finance is helpful in solving many
practical problems. Public finance is therefore an art also.
In sort, public finance is both science and art. It is a positive
science as well as normative science.
Scope of Public Finance (Subject Matter of Public Finance)
The scope of public finance may be summarised
as under:
1.
Public Revenue
2.
Public Expenditure
3.
Public Debt
4.
Financial Administration
5.
Economic Stabilisation
1.
Public
Revenue: Public revenue concentrates on the methods of raising public
revenue, the principles of taxation and its problems. In other words, all kinds
of income from taxes and receipts from public deposit are included in public
revenue. It also includes the methods of raising funds. It further studies the
classification of various resources of public revenue into taxes, fees and
assessment etc.
2.
Public
Expenditure: In this part of public finance we study the principles and
problems relating to the expenditure of public funds. This part studies the
fundamental principles that govern the flow of Government funds into various
streams.
3.
Public
Debt: In this section of public finance, we study the problem of raising
loans. Public authority or any Government can raise income through loans to
meet the short-fall in its traditional income. The loan raised by the
government in a particular year is the part of receipts of the public
authority.
4.
Financial
Administration: Now comes the problem of organisation and
administration of the financial mechanism of the Government. In other words,
under financial or fiscal administration, we are concerned with the Government
machinery which is responsible for performing various functions of the state.
5.
Economic
Stabilization: Now –a-day’s economic stabilization and growth are the two aspects
of the Government economic policy which got a significant place in the
discussion on public finance theory. This part describes the various economic
polices and other measures of the government to bring about economic stability
in the country.
From the
above discussion, we can say that the subject-matter of public finance is not
static, but dynamic which is continuously widening with the change in the
concept of state and functions of the state. As the economic and social
responsibilities of the state are increasing day by day, the methods and
techniques of raising public income, public expenditure and public borrowings
are also changing. In view of the changed circumstances, it has given more
responsibilities in the social and economic field.
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Also Read:
2. Public Finance Question Papers (Dibrugarh University)
3. Public Finance Solved Question Papers (Dibrugarh University)
5. Public Finance Important Questions for Upcoming Exam
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There is great socio-economic significance of public finance, both
in developed and developing countries. In developed country countries,
price-stability and full employment are the main economic goals of public
finance. In developing countries, rapid economic development through capital formulation
and creation of infrastructure art the important goals of public finance
operations. Socially equitable distributions of income, reduction of
inequalities in income are some important functions of public finance
operations. The importance of public finance can be clarified from the
following functions.
1. TO INCREASE THE RATE OF SAVING AND INVESTMENT: Most of the
people spend their income on consumption. Saving is very low so the investment
is also low. The government can encourage the saving and investment.
2. TO SECURE EQUAL DISTRIBUTION OF INCOME AND WEALTH: Unequal
distribution of income and wealth is the basic problem of the under developed
countries. The rich are getting richer and richer while the poor are becoming
poorer and poorer. So for the equal distribution of income and wealth there is
need of government.
3. OPTIMUM ALLOCATION OF RESOURCES: Fiscal measures like taxation
and public expenditure programmers can greatly affect the allocation of
resources in various occupation and sectors.
4. CAPITAL FORMULATION AND GROWTH: Fiscal policy will be designed
in a manner to perform two functions as of expanding investment in public and
private enterprises and by diverting resources from socially less desirable to
more desirable investment channels.
5. PROMOTING ECONOMIC DEVELOPMENT: The state can play a prominent
role in promoting economic development especially through control and
regulation of economic activities. It is fiscal policy which can promote
economic development.
6. IMPLEMENTATION OF PLANNING: Under democratic planning fiscal
policy plays crucial role as financial plan is as much important as physical
plan and the implementation of the financial will obviously depend upon the
uses of fiscal measures.
7. INFRASTRUCTURE BUILDING: Public finance helps to build up
well-development physical and institutional infrastructure.
8. TO CONTROL INFLATION: The imbalance between demand for and
supply of real resources may lead to inflations to under-development countries
inflation ruins the entire economic structure of the national and the process
of economic development in these countries comes to stand still. So to check
inflation, budgetary policies can be used by the government.
Role of public finance in an underdeveloped country like India
Public Finance occupies great significance in
an underdeveloped or developing country. According to R. J. Chelliah, “Public
finance has a positive and significant role in the context of economic
development.” The importance of public finance in an underdeveloped/developing
country like India may be summarized as under:
a) Capital Formation: Since
development entirely depends on the rate of capital formation in the country,
the first and foremost aim of public finance is to promote capital formation.
Students of commerce and economics are well aware of the fact that the burning
problem of an underdeveloped or developing country is the low capital
formation. In the words of Dr. Baljit Singh, “For an undeveloped country all
economic policies and measures in the initial stages must concentrate on
production and fiscal policy should act as a tool of capital formation.”
Capital formation can be increased through an effective and well-planned
taxation policy. In the words of R. Nurkse, “For economic development, it is not
the aim of public finance to bring about reduction in inequalities of incomes
but its aim is to increase that proportion of the income which goes into
capital formation.”
b) Unemployment Problem: Another
major problem of an underdeveloped/developing country is the unemployment
problem. Increased income may be eaten up by a large mass of unemployed people.
This problem of unemployment leads again to low standard of living, poverty,
backwardness, ignorance and above all starvation. It is the function of public
finance to provide employment opportunity. In the connection must be remembered
that fiscal policies (public finance policies) are most effective tools for
tackling of the problem of unemployment.
c) Planned Economic Development: In
underdeveloped/developing countries the productive resources are limited in
quantity as well as quality. Public finance renders valuable help in the
planned economic development of the country. The entire machinery of planning
works through the mechanism of public finance. The principles of public finance
have paramount importance in the sphere of rapid economic planning because both
of these are the closely related activities of the state. For example, the
Government of India is raising necessary funds through taxation etc. for
formulation and implementation of its five year plans.
d) Increase in Income: Capital
formation is not an end in itself but only a means of achieving another
important end, i.e. increase in income. The object of public expenditure is to
increase the income in underdeveloped countries so at to invest funds in such
industries and in such an economical and efficient manner that least amount of
money fetches the greatest possible output. The Government gives subsidies and
grants to industries to enable them to increase production at cheaper rates.
This will lead to prosperity and development with an overall increase in the
income of the masses.
e) Reduction in Economic Inequalities: Another
problem of underdeveloped or developing countries is the unequal distribution
of income and wealth to the public. Public finance has an important role to
play in this context. For example, the Government can impose heavy taxes (such
as income tax) on the richer sections of the society and spend the income so
received on providing cheap food, cheap housing, employment, free medical aid
etc. for poorer sections of the society.
f) Optimum Utilization of Resources: Another
major problem of underdeveloped or developing countries is the problem of
non-utilization or even destruction of the scarce and limited resources. The
solution of this basic problem lies in the optimum utilization of these
available resources by means of adopting planned monetary and public finance
policies. The state can direct the flow of consumption, production and
distribution in the right direction by adopting balanced budget policy.
g) Problem of Economic Stabilization: Another
problem of an underdeveloped and developing country is the economic
instability. After 1929-30 worldwide depression, it has been emphasised that
public finance (revenue and expenditure process of the Government) may be used
to secure economic stability or to remove economic fluctuations and distortion
in the economy.
h) Increase to Savings: The major
problem of developing and underdeveloped countries is that savings are very
nominal which hinder their economic development. Public finance encourages the
accumulation of savings.
Public Finance and Private Finance
Generally, the word ‘finance’ is loosely used
for both the public and private finance. By private finance, we mean the study
of the income, debt and expenditure of an individual or a private company or
business venture. On the other hand public finance deals with income, expenditure
and borrowings of the government. There are both similarities and
dissimilarities in governmental financial operations as compared to the
monetary operations of private businessman. An individual is interested in the
utilisation of labour and capital at his disposal to satisfy social wants. In
short, both private finance and public finance have almost the same objective
of satisfaction of human wants. Again, private finance stresses individual
gains whereas public finance attempts at promoting social welfare of the whole
community. These two view points are correct to greater extent only because of
their similarities as well as dissimilarities between both.
Similarities
between Public and Private Finance
1. Both the
State as well as individual aim at the satisfaction of human wants through
their financial operations. The individuals spend their income to satisfy their
personal wants whereas the state spends for the satisfaction of communal or
social wants.
2. Both the
States and Individual at times have to depend on borrowing, when their
expenditures are greater than incomes.
3. Both
Public Finance and Private Finance have income and expenditure. The ultimate
aim of both is to balance their income and expenditure.
4. For both
kinds of finances, the guiding principle is rationality. Rationality is in the
sense that maximization of personal benefits and social benefits through
corresponding expenditure.
5. Both are
concerned with the problem of economic choice, that is, they try to satisfy
unlimited ends with scarce resources having alternative uses.
Dissimilarities between Public and Private
Finance
1. The
private individual has to adjust his expenditure to his income. i.e., his
expenditure is being determined by his income. But on the other hand the
government first determines its expenditure and then the ways and means to
raise the necessary revenue to meet the expenditure.
2. The
government has large sources of revenue than private individuals. Thus at the
time of financial difficulties the state can raise internal loans from its
citizens as well as external loans from foreign countries. In the case of
private individual, all borrowings are external in nature.
3. The state,
when hard pressed, can resort to printing of currency, as an additional source
of revenue. In fact, during emergencies like war, it meets its increased
financial obligations by printing new currency. But an individual cannot raise
income by creating money.
4. The state
prepares its budget or estimates its income and expenditure annually. But there
is no such limitation for an individual. It may be for weekly, monthly, or
annually.
5. A surplus
budget is always good for a private individual. But surplus budgets may not be
good for the government. It implies two things. a) The government is levying
more taxes on the people than is necessary and b) the government is not
spending as much as the welfare of the people as it should.
6. The
individual and state also differ in their motives regarding expenditure. The
individuals hanker after profit. Their business operations are guided by
private profit motive. But the states expenditure is guided by the welfare
motive.
7. An
individual’s spending policy has very little impact on the society as a whole.
But the state can change the nature of an economy through its fiscal policies.
8. The
pattern of expenditure in the case of private finance is often influence by
customs, habits social status etc. The pattern of government expenditures is
guided by the general economic policy followed by the government.
9. Private
Finance is always a secret affair. Individual need not reveal their financial
transactions to anyone except for filing tax returns. But Public Finance is an
open affair. Government budget is widely discussed in the parliament and out
sides. Public accountability is an important feature of public finance.
10. Individuals can plan to postpone their private expenditure. But the state cannot afford to put off vital expenditure like defence, famine relief etc.
THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
One of the important principles of public
finance is the so – called Principle of Maximum Social Advantage explained by
Professor Hugh Dalton. Just like an individual seeks to maximize his
satisfaction or welfare by the use of his resources, the state ought to
maximize social advantage or benefit from the resources at its command.
The principles of maximum social advantage are
applied to determine whether the tax or the expenditure has proved to be of the
optimum benefit. Hence, the principle is called the principle of public
finance. According to Dalton, “This (Principle) lies at the very root of public
finance” He again says “The best system of public finance is that which secures
the maximum social advantage from the operations which it conducts.” It may be
also called the principle of maximum social benefit. A.C. Pigou has called it
the principle of maximum aggregate welfare.
Public expenditure creates utility for those
people on whom the amount is spent. When the volume of expenditure is small
with a slighter increase in it, the additional utility is very high. As the
total public expenditure goes on increasing in course of time, the law of
diminishing marginal utility operates. People derive less of satisfaction from
additional unit of public expenditure as the government spends more and more.
That is, after a stage, every increase in public expenditure creates less and
less benefit for the people. Taxation, on the other hand, imposes burden on the
people.
So, when the volume of taxation becomes high,
every further increase in taxation increases the burden of it more and more.
People under go greater scarifies for every additional unit of taxation. The
best policy of the government is to balance both sides of fiscal operations by
comparing “the burden of tax” and “the benefits of public expenditure”. The
State should balance the social burden of taxation and social benefits of
Public expenditure in order to have maximum social advantage.
Attainment of maximum social advantage
requires that;
a) Both public expenditure and taxation should
be carried out up to certain limits and no more.
b) Public expenditure should be utilized among
the various uses in an optimum manner, and
c) The different sources of taxation should be
so tapped that the aggregate scarifies entailed is the minimum.
Assumptions of this theory:
1.All taxes result in sacrifice and all public
expenditures lead to benefit.
2. Public revenue consists of only taxes and
there is no other source of income to the government.
3. The govt. has no surplus or deficit budget
but only a balanced budget.
Diagrammatical Explanation of the theory of
maximum social advantages
In the above diagram, MSS is the marginal social sacrifice curve sloping upward from left to right. This rising curve indicates that the marginal social sacrifice goes on increasing with every additional dose of taxation. MSB is the marginal social benefit curve sloping downwards from the left to right. This falling curve indicates that the marginal social benefit diminishes with every additional dose of public expenditure. The two curves MSS and MSB intersect each other at the point P. PM represent both marginal social sacrifice as well as marginal social benefit. Both are equal at OM which represents the maximum social advantage.
Criticism of the theory of Maximum
Social Advantages
1. Non measurability of social sacrifice
and social benefit: The major drawback of this principle is that it is not
possible in actual practice to measure the MSS and MSB involved in the fiscal
operation of the state.
2. Non applicability of the low of
equimarginal utility in public expenditure: The low of equimarginal utility may
be applicable to private expenditure but certainly not to public expenditure.
3. 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.
4. Lack of divisibility: The marginal benefit
from public expenditure and marginal sacrifice from taxation can be equated
only when public expenditure and taxation are divided into smaller units. But
this is not possible practically.
5. Assumption of static condition: Conditions
in an economy are not static and are continuously changing. What might be
considered as the point of maximum social advantage under some conditions may
not be so under some other.
6. 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
7. "The govt. has no surplus or deficit
budget but only a balanced budget."- is an invalid assumption.
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Also Read following notes:
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Also Read:
2. Public Finance Question Papers (Dibrugarh University)
3. Public Finance Solved Question Papers (Dibrugarh University)
Economic tests of social advantage as suggested by Dr. Dalton
In view of some difficulties in the
way of subjective measurement of social advantage, Dr. Dalton has suggested
certain tests which enhance social advantage of the community as a whole. They
are objective basis tests which are follows:
1) Expenditure on Defence, Law and Order: It is the
primary duty of the state to safeguard the country and the community from
external attack and internal disorders. Internal peace and external security
create confidence and promote economic life of the community and, thus enhance
social advantage. It is, therefore, essential to maintain army, police,
judiciary, prisons etc. so as to meet internal and external threats to the
country and the community. Although it is an unproductive expenditure, it is to
be incurred by all means. However, Dr. Dalton has suggested that the state
should adopt a policy of peace and co-existence for home and abroad otherwise
unproductive expenditure on army, police, judiciary, prisons etc. would
increase and this may have an adverse effect upon the economic life of the
country as well as the community.
2) Increase in Economic Welfare: Second
objective of public finance should be to increase economic welfare. Increase in
economic welfare depends upon the following two things:
a) Increase
in Production: The operation of public finance should be in such a way that
there is increase in production in the community. Increase in production
implies (a) maximum increase in production power with minimum efforts; (b)
improvement in the organization of production so as to reduce a minimum wastage
of economic resources through unemployment and other causes; and (c)
improvement in the composition or pattern of production so as to best serve the
needs of the community.
Hence the operation of public finance should
aim at securing all these objectives so at to increase production and economic
welfare of the community.
b) Improvement
in the Distribution of Income and Welfare: Increase in production is
insufficient and ineffective unless it is accompanied with an improvement in
the distribution of income and wealth in order to achieve economic welfare in
the society. Hence, it is the duty of every state to see that what is produced
should be properly distributed among the different sections of the community,
i.e. it should reduce the inequalities and fluctuations of income in the
community. In the words of Dr. Dalton, “Improvement in distribution resolves
itself into (a) reduction in the great inequality in the incomes of different
individuals and families; (b) reduction in the great fluctuations between
different periods of time, in the income of particular individuals and
families, especially among the poor sections of the community.” Thus, proper
distribution of income and wealth is also essential for increasing economic
welfare.
3)
Economic
Stability and Full Employment: Economic instability in the country is
the characteristic of free economies and is also the cause of so many evils,
such as unemployment, heavy booms and depressions, overproduction,
underproduction etc. in the community. If economic stability is maintained in
the country, it will provide employment to maximum persons, increase production
and promote greater equality of income. Hence fiscal operations should be
enforced in such a way so that the undue boom and undue depressions are
controlled and employment is provided to maximum persons. For example, fiscal
operations can reduce the effects of depression by increasing public
expenditure on public works. Similarly, effects of inflation can be reduced by
public borrowings, heavy taxation etc.
4)
Provisions
of Future: The state has double responsibility of looking after the
interests of present generation as well as of future generations. The state
should choose a greater advantage of future generations and that of a small
advantage to present generation.
According
to Dr. Dalton, “The statesman is a trustee for the future, no less than for
present. Individuals die, but the community, which they form, lives on. The
statesman, therefore, should prefer a larger social advantage in the future to
a smaller one of today.” From this point of view, soil conservation, protection
of limited and scarce natural resources and expenditure on long-term plans
(such as India’s Five Year Plan) is desirable.
To
conclude, it is not absolutely wrong to condemn all taxes, nor is it correct to
justify all government expenditure. It is necessary to test all fiscal
operations on the basis of maximum social advantage. The principle of maximum
social advantage is the fundamental principle of public finance.
Various concept/theories of Public Finance
1) Classical Concept of Public Finance: Classical
concept of public finance is based on classical general economic theory. The
classical economic theory assumed that supply creates its own demand and,
therefore, there can never be any great unemployment or over-production. It
assumes full employment, i.e. fuller utilization of public resources. If
unemployment by chance happens to exist, it is purely temporary and may be
voluntary in nature and that too due to the miscalculations of entrepreneurs.
But if it is left to the nature itself; price, wages, interest flexibility
could automatically bring equilibrium between supply and demand of commodity,
labour and capital. Hence, there is no need of any state intervention in the
socio-economic affairs of the country. If the state raises its expenditure by
taxation it would be merely a substitution for expenditure by private persons.
If the state raises its expenditure through borrowing, it would be competing
with private individuals and this would raise price and give way to inflation.
It means that they believed that the state would not increase the level of
economic activity within the country. Since taxes have always some effect on
private savings, a reduction in private savings may result in low level of
private investment. Hence, taxes have an adverse effect on accumulation of
capital. Therefore, they believed that best budget is small budget. They
favoured indirect taxation. A budget deficit will lead to inflation. They
believed that the budget should be well balanced. In short, the following are
the main points of classical theory of public finance:
a) The best
budget is a small budget.
b) The budget
should be well balanced.
c) The state
should not increase the level of economic activity.
d) If a
deficit cannot be avoided, issue long-term bonds.
e) Indirect
taxation is better as against the direct taxation.
f) Borrow
only for the purpose of productive investment.
On the basis of the above study, we conclude
that the scope of public finance was limited according to classical economists.
2)
Keynes’
Theory of Public Finance: Functional Finance Keynes and Hansen have
given us the ‘new economics’ which is primarily a new concept of public
finance. They assume that a capitalist economy by itself cannot function and
thereby the government will have to come to the rescue of the economy at
certain times. They emphasize compensatory action through fiscal policy to
stabilize and regulate the economic system of a country. The Keynesian concept
of public finance has been called functional finance by Abba P. Lerner.
Functional finance is the system of judging fiscal measures by the way they
function in the economy. Functional finance reduces fiscal operation of
taxation, public expenditure and the public debt to operations of policy so as
to reduce the volume of money and the aggregate demand in the country. For
example, according to functional finance, the main function of taxation is not
to secure funds for the state but to be an effective weapon in the hands of the
state so as to reduce the purchasing power of the people. In the same way, the
main function of public expenditure is to influence the volume of aggregate
demand to equal aggregate supply.
Thus, the old precepts vanished, economists
began to visualize the instrument of fiscal policy as a means of promoting a
healing to their economy. Public finance became Functional Finance signifying a
study of the fiscal functions of the government that could eliminate unwanted
distortions and fluctuations in the economic activity.
3)
Taxation
and Equitable Distribution: The use of taxation as a powerful instrument
for transferring income from the rich to the poor was not favoured by classical
economists. However, in the modern concept of public finance, taxation is
considered as an important means of reducing economic inequalities of income
and thereby promoting social justice. Further classical economists favoured
taxing the poor than the rich, i.e., they favoured indirect taxation. But
modern economists believed in taxing those who are able to save rather than
those who are anxious to consume, i.e. taxing the rich rather than the poor.
Moreover, contrary to the classical economists, modern economists favoured
progressive and direct taxation as an instrument of collecting public revenues
and to make equitable distribution of income in the country. Now unearned
income is considered socially undesirable and, therefore, an attempt is also made
to confiscate a portion of unearned income through direct taxes, such as gift
tax, wealth tax, death duty etc. Modern economists do not recommend taxing
every item of expenditure but only those items which do not adversely affect
the general welfare of the masses. Hence, indirect taxes are recommended on
those commodities which are generally consumed by the rich and not by the poor.
According to Prof. Musgrave, public finance
deals with the economics of public sector including not only its financing but its
entire bearing on the level of and allocation of resources as well as on the
distribution of income among consumers. And the importance of the public sector
lies in the fact that the market mechanism alone cannot perform all economic
functions. Thereby, public policy is needed to guide, correct and supplement it
(i.e. market mechanism) in certain respects. Prof. Musgrave assigned three
important responsibilities to the public policy; (i) securing adjustments in
the allocation of resources, (ii) securing economic stabilization growth.
The modern concept of public finance gives
importance to the distribution branch of economics. The function of the
distribution branch is to determine as to what steps are needed to bring about
the desired or equitable state of distribution in the economy.
Relationship of public finance with economics, politics, history, sociology, ethics, jurisprudence, psychology
Resemblances and differences among the sciences are the true bases for drawing up a clear line of demarcation between them. Public finance has much to take and much to give to the sciences like economics, politics, history, jurisprudence etc. As a matter of fact, public finance is a curious mixture of all these sciences as is evident from the following:
A) Public Finance and Economics: If economics is taken as a science which deals with the administration of scarce resources to satisfy human wants, public finance may be taken as that part of economics which deals with only the satisfaction of wants of the citizens of the state. Many of the problems of public finance are part of the subject-matter of economics. For instance, the problems of taxation are essentially a part of economics. Taxation implies shifting of resources from private hands to the government and, therefore, the shifting of utilization of resources by the individuals and the groups to the hands of the public authorities.
B) Public Finance and Politics: All social sciences are brothers or sisters in the sense that these deal with one or the other aspect of social life. In this manner politics can very well be described as a sister science of public finance. There is an intimate connection between voting and taxation. Much of public finance has political science aspects. According to Dr. Dalton, “Public finance is the borderline between economics and politics.”
C) Public Finance and History: No doubt, public finance is related with history but not so closely as it is related with economics and politics. Public finance has given shape to the nature of public finance as it has given to anything else. History puts up the lessons of the past before us in the sphere of public finance as it is in any other sphere. No finance policy can be formulated without keeping in view the historical development. History provides us with facts, figures and illustrations which is essential for the formulation of any finance policy.
D) Public Finance and Sociology: Social reforms which form the part of sociology, are now supposed to be the responsibility of the state and they need government finance for execution. In fact, these social reforms have enhanced the scope of public expenditure. For example, crimes are the topics which sociologist studies, but are the student of public finance who studies the raising of revenue from criminals of one kind or the other. Taxes on inheritance, gifts etc. may have their due effects on the social set-up of the society. In this way sociology is very much related to public finance.
E) Public Finance versus Law: The fiscal policy of a country, in general, is always based on the principles of equity and justice. All these terms have been borrowed from jurisprudence and in fact are based on the foundation of legal definitions. The law of the country is the basis on which taxes are imposed and funds are allocated. There are laws which prevent improper raising of funds and their improper allocations.
F) Public Finance and Ethics: There is also a close relationship between public finance and ethics. Equity and justice have as much to do with ethics as they have with law and therefore the relationship between public finance and ethics is obvious, if the fiscal policies are to be based on these principles. For instance, it is neither legal nor ethical to snatch Rs. 100 as tax from a person who earns hardly Rs. 200.
G) Public Finance and Psychology: Public finance is also related with psychology. Public finance deals with people and as such most of its problems are human problems and hence depend upon human behaviour which is the subject-matter of psychology. For example, take the case of taxation on company profits. Since profits may be taken as ‘rewards for risk taking’, an undue increase in the tax on company profits may adversely affect the spirit of risk taking and thereby affect investment in the companies.
From the above study, it is clear that public finance is related to many of the social sciences which deal with different aspects of human behaviour.
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