Public Finance: Meaning,
UNIT 1 PUBLIC FINANCE: MEANING, Types, Distinction Between
TYPES, DISTINCTION Public And Private Finance
BETWEEN PUBLIC AND PRIVATE
FINANCE*
Structure
1.0 Objectives
1.1 Introduction
1.2 Public Finance: Meaning
1.3 Public Finance: Types
1.4 Public Finance and Public Policy
1.5 Distinction between Public and Private Finance
1.6 Conclusion
1.7 Glossary
1.8 References
1.9 Answers to Check Your Progress Exercises
1.0 OBJECTIVES
After going through this unit, you should be able to:
Explain the meaning and the concept of public finance;
Describe the categorisation of public finance;
Discuss the interlinkages between public finance and public policy; and
Bring out the distinction between public and private finance.
1.1 INTRODUCTION
Public finance is a part of the study of economics. It borders on the fields of
government and political science. It deals with many of the same problems and shares
some of the techniques employed in the field of corporate economics, but essentially
it is contained within the field of economics. Public finance implies broadly the
money that is with the government. It is the branch of economics that assesses the
government revenues and expenditure and its adjustment to achieve the desirable
objectives. Thus, comprehending the essence of public finance depends upon an
understanding of the nature of economics. This unit provides an overview of the
concept of public finance, types, and differentiates it from private finance.
* Contributed by Dr. Anupama Puri Mahajan, Former Post-Doctoral Research Fellow (Public
Administration), Himachal Pradesh University, Shimla.
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Introduction to Public
Finance and Administration 1.2. PUBLIC FINANCE: MEANING
Public finance is defined as the study of the financial activities of government and
public authorities. It describes and analyses the expenditures of government and the
techniques used to finance these expenditures. It studies the activities discharged,
and services provided by the government and the taxes being used to generate its
funds. It examines the influence of government financial operations on growth,
employment, prices etc.
In simple terms, public finance is a study of the financial aspects of the government.
Charles F. Bastable stated, “public finance deals with expenditure and income of
public authorities of the State and their mutual relation as also with the financial
administration and control”. Public finance stands for the resources of a public body
and a study of the principles to acquire finances and using the funds for public services
and activities.
Carl Plehn defined public finance as, “the science which deals with the activity of
the statesman in obtaining and applying the material means necessary for fulfilling
the proper functions of the State”.
Findlay Shirras defined public finance as, “the study of the principles underlying the
spending and raising of funds by public authorities.”
Hugh Dalton considered public finance as “concerned with the income and
expenditure of public authorities and with the adjustment of the one to the other. The
principles of public finance are laid down regarding these matters”.
Musgrave stated that “the objectives of public finance are allocating resources for
the provision of public services and to ensure growth and development, ensure
macroeconomic stabilisation and bring about the desired distribution of incomes”.
It can be summarised from the above-mentioned definitions that public finance is
categorised into public income and public expenditure as two symmetrical branches
of the subject.
Public Finance in India
The objectives of public finance are to ensure microeconomic stability and the desired
distribution to be done by the State to provide public services to the people. It aims
at bringing about economic growth and development. Earlier, the private sector in
general was not entrusted with the responsibility of providing public services and
the public sector had to step in to fill this gap. The public services and goods are
called ‘merit goods’, for example, defending the property rights of the citizens or
maintaining law and order to create a conducive environment for economic growth.
The physical and social infrastructures are integral to the objectives of public finance.
The State’s role and activities are all linked to public finance.
In India, State intervention through policies related to public finance, includes ensuring
safety and security of the people, which are:
Protection of property rights of the citizens;
Reduction of wide regional disparities;
Development of physical and social infrastructure;
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Correction of markets; Public Finance: Meaning,
Types, Distinction Between
Lessening the gap between income inequalities; and Public And Private Finance
Provision of education, health care, sanitation and hygiene, support price to
agriculture etc.
Over time, increase in public spending on subsidies and transfers in employment
guarantee, food security, national housing schemes, periodic loan waivers and
recapitalisation of banks to meet the deficiencies of capital is being observed. In
India, public spending is beset with the issue of poor productivity. The government’s
flagship programmes, namely, Sarva Shiksha Abhiyan for elementary education and
National Health Mission for ensuring health for all, are unable to yield results because
of lack of flexibility and poor targeting. Even though there is an improvement in the
public spending in health and education sectors, the quality standards of the outcomes
are yet to come up to the acceptable norms.
1.3 PUBLIC FINANCE: TYPES
The area of public finance is studied by its categorisation into five types, which are:
1. Public Expenditure: The governments - union, state and local, spend money on
providing public services for collective social wants of citizens or other government
associated entities. Earlier, it used to be relatively much smaller amounts but with
the rise in governmental activities, there has been a tremendous increase in government
budgets in proportion to their activities. Some of the activities of a government that
call for increasing public expenditure are promotion of:
rapid economic growth;
rural development;
balanced regional growth;
trade and commerce;
agri-business, manufacturing, and service sectors;
social infrastructure;
social welfare; and various such areas which are needed to achieve inclusive growth
and the Sustainable Development Goals.
Given below are the types of public expenditure:
i. Capital and Revenue Expenditure: The capital expenditure results in the
creation of fixed assets as investment which adds up to the net productive assets
of the economy. It helps in the carrying out developmental works, for example,
building schools, hospitals, infrastructure, etc.
Revenue Expenditure: The current expenditures of a government which are
continual in nature such as civil administration, defence forces, etc.
ii. Productive and Non-Productive Expenditure: Promoting physical
infrastructure, public sector undertakings and developmental works in a country
is productive expenditure which provides income to the government.
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Introduction to Public Non-Productive Expenditure: Some governmental activities such as training,
Finance and Administration law, and order, etc. do not yield income to the government. It is non-productive
expenditure.
iii. Transfer and Non-Transfer Expenditure: Transfer expenditure or grants have
no corresponding transfer of real resources like old age pension. Non-transfer
expenditure results in exchange of goods and services for money. For example,
expenditure on education, posts, and telegraph etc.
iv. Plan and Non-Plan Expenditure: Plan expenditure involves the development
activities, while non-plan expenditure is outside the purview of the planned
expenditure such as the subsidies or social services. However, in India now the
distinction has been done away with.
v. Other Categorisations: There are some other categorisations according to the
functions of a government, which are:
Defence Expenditure
Civil Expenditure
Development Expenditure
2. Public Revenue: The gross income of a government from all resources is called
public revenue/income. The income of a public authority may be defined either
in a broad or a narrow sense. In the broad sense, it includes all “incomings” or
“receipts” whereas in the narrow sense, it includes only those receipts which are
related to revenue. The broad meaning is called ‘public receipts’ and the narrow
sense is called, ‘public revenue’. Public revenue does not include receipts from
public borrowings or public debt. There are two types of public revenue, which
are:
i. Tax Revenue: The tax policy in a country is an important tool through which
resources are transferred from the private sector to the government for
accumulating funds to deliver public services. The best practices considered by
national and international agencies recommend the following regarding raising
the tax revenue:
Minimising the collection costs;
Reducing the compliance costs;
Provision of a broad base;
Laying down low rate;
Lessening the rate of differentiation; and
Maintaining a transparent tax system.
A government has the right to impose taxes and duties to raise revenue to fund its
developmental works and the provision of public services. It includes direct and
indirect taxes; fees; fines and penalties; special assessments; price; gifts and donations;
and grants-in-aid.
ii. Non-Tax Revenue: It includes the public income that is received from
administration, public sector undertakings, gifts, and grants. This includes:
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Administrative Revenue –These include funds in the form of fees, fines, penalties, Public Finance: Meaning,
and special assessments raised by public agencies. Types, Distinction Between
Public And Private Finance
Profits from Public Sector Undertakings (PSUs) –The PSUs, if they make profits,
are a source of non-tax revenue.
Gifts and Grants – These are generally be given by another government or any
institution.
Problems in the Indian Tax System
India in general faces the problem of low revenue productivity and a narrow tax
base. The reasons for a narrow tax base are:
Fragmentation of the Constitutional assignment of taxes.
Ambiguity in the objectives of tax policy which leads to tax evasion and
avoidance.
Non-compliance of taxation rules by the multinational companies results in tax
base erosion and diverting of profits;
Difficulty in enforcement of tax laws is due to overburdened tax administrative
machinery.
Deficiencies in the data and information systems in the tax departments and
agencies.
The tax system is required to achieve objectives such as incentivising savings,
promoting exports, achieving balanced regional development, promoting investments
in the economy.
3. Public Debt: The government‘s borrowing constitutes public debt.
4. Financial Administration: The entire gamut of the processes and systems
through which public finance is managed. The fourth type of public finance is
the financial administration, which deals with the public expenditure and public
revenue through the budgeting procedure. We shall be discussing this in detail
in subsequent units of this Course.
5. Economic Stability and Growth Policies: This includes the various policies
and measures to ensure economic stability and growth.
Check Your Progress 1
Note: i) Use the space given below for your answers.
ii) Check your answers with those given at the end of the unit.
1) What do you understand by the concept of public finance?
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2) Elaborate on the types of public finance.
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Introduction to Public
Finance and Administration 1.4 PUBLIC FINANCE AND PUBLIC POLICY
The Ministry of Finance deals with public finance to allocate funds within the
constraints of the budget with proper mandated procedures. Public finance
encompasses evaluation of the Indian government’s policies included in the Union
budget along with other functions. Its main activity is to improve and update the
economic procedures pertaining to the policies of the government.
Public finance and public policy are intricately linked with each other in India and in
other democracies as well. Public policy sorts out the issues of public finance. There
are two policies that fall under public finance, which are:
1. Fiscal Policy: It is the overall government policy framework which is formulated
by considering the government’s income, expenditure, and borrowings.
2. Monetary Policy: The monetary policy is formulated with respect to the amount
of funds, rates of interest and exchange. The Government has the responsibility
of keeping the aggregate demand and inflation in check. The government has
the following objectives to achieve through the monetary policy:
Bringing in equity in wealth and income distribution to reduce the gap between
the rich and the poor;
Increasing the rate of economic growth and sustaining it by a proportional
increase in savings and public spending;
Attaining optimum resource allocation through taxation and subsidies; and
Stabilising the economy by keeping fluctuations at bay.
Indian Public Finance: Deficits and Debt
Public debt is the debt owed by the government. On the other hand, public deficit is
the difference between government receipts and its spending in a fiscal year. The
developing countries are facing large fiscal deficits. In the past decade, there has
been a marked increase in the infrastructural growth. The developed countries have
managed to control their public debt by keeping it at a domestic level whereas the
developing nations could not do so and had to resort to external borrowings also.
The higher the fiscal deficit in an economy, larger is the public debt. Hence, it can be
said that fiscal debts are a prerequisite for the accumulation of the public debt.
However, if the fiscal deficit is financed by foreign grants and monetary expansion,
it does not lead to a rise in the public debt.
Public debt management and fiscal deficit control are part of public finance. There
could be various reasons of growth in public debt such as, war, developmental
expenses, accessibility to low rates of interest, etc.
The Government of India published its first Debt Management Strategy (DMS) on
December 31, 2015. The objective of this is to secure the government’s funding at
low cost over the medium /long-term loans while avoiding excessive risk. The DMS
has been laid down for the medium-term for a period of three years and would be
reviewed annually and rolled over for the next three years.
In India, the public debt is largely funded through domestic savings, using largely
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fixed interest rate instruments and has a large domestic institutional investor base. Public Finance: Meaning,
There must be limits to borrowing as a source of financing public spending. In normal Types, Distinction Between
Public And Private Finance
times, the golden rule is that all current expenditures for paying salaries, interest,
maintenance of capital assets, subsidies and other transfers should be financed from
current revenues, and tax and non-tax sources while capital expenditure could be
financed from borrowing. This is only a broad rule to ensure that borrowed funds are
used to finance expenditures which would accelerate the growth rate of the economy
that balances the interest to be paid on the borrowing.
While it is not possible to give a general rule on the optimal level of deficits and
debt, borrowing can be resorted to so long as it leads to net increase in employment
and incomes. Excessive borrowing to finance public spending can have severe adverse
implications. First, as already mentioned, excessive drawing of household sector’s
financial savings would put upward pressure on interest rates and crowd out private
investments. Second, high volume of debt results in high interest payments which
pre-empts public spending on productive activities. Third, borrowings now will have
to be repaid later through higher taxes and therefore, involves a burden on the future
generation. Fourth, high deficits could lead to balance of payment problems. For
these reasons credit rating agencies attach high risk perception to countries with
high levels of deficits and debt resulting in higher borrowing at international costs.
Therefore, in many countries, fiscal rules are legislated to contain the levels of deficits
and debt. In India, there have been concerns about the deficits and debt for long and
the economic crisis of 1991 was mainly attributed to lax fiscal policy.
1.5 DISTINCTION BETWEEN PUBLIC AND
PRIVATE FINANCE
There is a clear distinction between private and public finance. Public finance refers
to the public funds and their utilisation to meet people’s needs, whereas private
finance alludes to individual wealth. Given below are the differences in Table
No. 1.1:
Table No. 1.1: Distinction between Public and Private Finance
S. No. Public Finance Private Finance
1. The government agencies balance Individual adjusts the
their income and expenditure. expenditure to the income.
2. A government agency does not save Individuals tend to save money
any funds and has to spend and keep it aside for rainy
whatever revenues have been days or simply to have a
accrued. surplus budget.
3. The government agencies have the A person can only take loan
power to raise loans internally and from another person or from
externally. another external agency.
4. There is flexibility in public finances, Individuals do not have
for example, the government can unlimited funds.
resort to deficit financing.
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Introduction to Public 5. The government can take recourse to An individual cannot use
Finance and Administration
compulsive measures. compulsive measures to get
income.
6. The government in case of any A private individual cannot
emergency has the authority to print print notes.
notes.
7. The scope of public finance is wide. Private finance has limited
scope.
8. Has a compulsory characteristic as Private finance can be optional
it has to incur certain expenditure as some expenses can be
which is necessary for example, postponed.
defence or civil administration.
It can be summarised that public sector finance comprises all the government owned
agencies, companies, and other offices with the objective of creating social benefits.
The main beneficiary is the citizen. Public finance many a times faces the problem
of scarcity. On the other hand, private finance is related to the corporate sector and
individuals. The beneficiary of private finance is the individual. However, public,
and private finance both contribute to the economy and rely on each other towards
economic growth.
Check Your Progress 2
Note: i) Use the space given below for your answer.
ii) Check your answers with those given at the end of the unit.
1) Distinguish between public and private finance.
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1.6 CONCLUSION
Public finance is a key component of government activity. It deals with government
revenue, expenditure, public debt, borrowings, and related financial aspects. This
unit provides an overview of the concept of public finance, types, and its linkages
with public policy and makes distinction between public and private finance.
1.7 GLOSSARY
Debt Management Strategy: It is the strategy laid down by the government to
secure funds at low cost over medium/long-term to avoid excessive risks. It revolves
around low cost, risk mitigation and market development.
E-commerce: It is the activity of buying and selling of products and services through
electronic means, online over internet.
Fiscal Policy: It is the policy that indicates the use of government spending and tax
policies to influence economic conditions including demand for goods and services,
employment, inflation, economic growth etc.
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National Health Mission: This was launched by Government of India in 2013 to Public Finance: Meaning,
achieve universal access to equitable, affordable, and quality health care services to Types, Distinction Between
Public And Private Finance
the people.
Recapitalisation: It is the strategy of enhancing the financial base of a company or
institution (public or private) by putting more finances to overcome a rough financial
situation or enhance its financial health.
Sarva Shiksha Abhiyan: It is the Government of India’s flagship Programme for
achievement of universalisation of Elementary Education (UEE) in a time bound
manner. It was mandated by the 86th Constitutional Amendment Act making free and
compulsory education to the children of 6-14 years of age, a fundamental right.
Sustainable Development Goals: These are global goals laid down in 2015 by United
Nations General Assembly, for all the countries to achieve a better and sustainable
future for all by 2030.
1.8 REFERENCES
Aronson, R.J. (1985). Public Finance. New York, USA: McGraw Hill Inc.
Cauvery, R. et.al. (2007). Public Finance – Fiscal Policy. New Delhi, India: S.
Chand & Company.
Dalton, H. (2003). Principles of Public Finance. London, UK: Rutledge.
Government of India. (2018). Status Paper on Government Debt. New Delhi, India:
Department of Economic Affairs, Ministry of Finance.
Mahajan S. K. & Mahajan, A. (2014). Financial Administration in India. New Delhi,
India: PHI India.
Musgrave, R.M. (1959). The Theory of Public Finance. New York: Mc-Graw Hill
Book Company.
Rao, M.G. (2017). Public Finance in India in the Context of India’s Development.
Working Paper No. 219. New Delhi, India: National Instituted of Public Finance and
Public Policy.
Rao, M.G. (2017). The Effect of Intergovernmental Transfers on Public Services in
India. Working Papers 17/218. New Delhi, India: National Instituted of Public Finance
and Public Policy.
Reed, B. J. & Swain, J.W. (1997). Public Finance Administration. New Delhi, India:
Sage Publications.
1.9 ANSWERS TO CHECK YOUR PROGRESS
EXERCISES
Check Your Progress 1
1) Your answer should include the following points:
Public finance is the branch of economics that assesses the government
revenues and expenditure and its adjustment to achieve the desirable
objectives.
25
Introduction to Public Public finance is defined as the study of the financial activities of governments
Finance and Administration and public authorities. It describes and analyses the expenditures of
governments and the techniques used by governments to finance these
expenditures.
It is divided between public income and public expenditure as its two
symmetrical branches of the subject.
2) Your answer should include the following points:
Public expenditure: The governments at the Union, State and local levels
spend money on providing public services for collective social wants of
citizens or other government associated entities.
Types of public expenditure:
i. Capital and Revenue Expenditure;
ii. Productive and Non-Productive Expenditure
iii. Transfer and Non-Transfer Expenditure
iv. Plan and Non-Plan Expenditure
v. Other Categorisations
Public revenue: The income of a public authority may be defined either in
a broad or a narrow sense. The narrow sense is called, ‘public revenue’.
Public revenue does not include receipts from public borrowings or public
debt. There are two types of public revenue, which are:
i. Tax revenue
ii. Non-tax revenue
Public debt
Financial Administration
Economic Stability and Growth Policies
Check Your Progress 2
1) Your answer should include the following points of distinction:
Balance of income and expenditure;
Savings
Raising of loans;
Flexibility;
Compulsive measures; and
Printing of notes.
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