Public Finance

WHAT IS PUBLIC FINANCE?

In simple layman terms, public finance is the study of finance related to government entities. It revolves around the role of government income and expenditure in the economy.

Prof. Dalton in his book Principles of Public Finance states that “Public Finance is concerned with income and expenditure of public authorities and with the adjustment of one to the other”

By this definition, we can understand that public finance deals with income and expenditure of government entity at any level be it central, state or local. However in the modern day context, public finance has a wider scope – it studies the impact of government policies on the economy.

Let’s understand the scope of public finance to understand how public finance impacts the economy.

Components of Public Finance

The main components of public finance include activities related to collecting revenue, making expenditures to support society, and implementing a financing strategy (such as issuing government debt). The main components include:

  1. Tax collection

Tax collection is the main revenue source for governments. Examples of taxes collected by governments include sales tax, income tax (a type of progressive taxes, estate tax, and property tax. Other types of revenue in this category include duties and tariffs on imports and revenue from any type of public services that are not free.

2. Budget

The budget is a plan of what the government intends to have as expenditures in a fiscal year. In the U.S., for example, the president submits to Congress a budget request, the House and Senate create bills for specific aspects of the budget, and then the President signs them into law

3. Expenditures

Expenditures are everything that a government actually spends money on, such as social programs, education, and infrastructure. Much of the government’s spending is a form of income or wealth redistribution, which is aimed at benefiting society as a whole. The actual expenditures may be greater than or less than the budget.

4. Deficit/Surplus

If the government spends more then it collects in revenue there is a deficit in that year. If the government has less expenditures than it collects in taxes, there is a surplus.

5. National Debt

If the government has a deficit (spending is greater than revenue), it will fund the difference by borrowing money and issuing national debt. The U.S. Treasury is responsible for issuing debt, and when there is a deficit, the Office of Debt Management (ODM) will make the decision to sell government securities to investors.

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FUNCTIONS OF PUBLIC FINANCE

There are three main functions of public finance as follows –

THE ALLOCATION FUNCTION

There are two types of goods in an economy – private goods and public goods. Private goods have a kind of exclusivity to themselves. Only those who pay for these goods can get the benefit of such goods, for example – a car. In contrast, public goods are non-exclusive. Everyone, regardless of paying or not, can benefit from public goods, for example – a road.

The allocation function deals with the allocation of such public goods. The government has to perform various functions such as maintaining law and order, defense against foreign attacks, providing healthcare and education, building infrastructure, etc. The list is endless. The performance of these functions requires large scale expenditure, and it is important to allocate the expenditure efficiently. The allocation function studies how to allocate public expenditure most efficiently to reap maximum benefits with the available public wealth.

THE DISTRIBUTION FUNCTION

There are large disparities of income and wealth in every country in the world. These income inequalities plague society and increase the crime rate of the country. The distribution function of public finance is to lessen these inequalities as much as possible through redistribution of income and wealth.

In public finance, primarily three measures are outlined to achieve this target –

▪ A tax-transfer scheme or using progressive taxing, i.e. in simpler words charging higher tax from the rich and giving subsidies to the low-income

▪ Progressive taxes can be used to finance public services such as affordable housing, health care, etc.

▪ A higher tax can be applied to luxury goods or goods that are purchased by the high-income group, for example, higher taxes on luxury cars.

THE STABILIZATION FUNCTION

Every economy goes through periods of booms and depression. It’s the most normal and common business cycles that lead to this scenario. However, these periods cause instability in the economy. The objective of the stabilization function is to eliminate or at least reduce these business fluctuations and its impact on the economy. Policies such as deficit budgeting during the time of depression and surplus budgeting during the time of boom helps achieve the required economic stability.

Now that we understand the study of public finance, we must look into its practical applications. So let us understand the career opportunities in public finance –

CAREER OPPORTUNITIES IN PUBLIC FINANCE

INVESTMENT BANKING

An investment banking career in public finance domain entails raising funds for the development of public projects. Investment bankers help government entities in the following three areas –

▪ Raise funds by underwriting debt securities such as bonds, debentures, commercial papers, etc.

▪ Analyzing project finance opportunities for large government projects and raising debt and equity funds for such projects.

▪ Advising government companies on mergers and acquisitions, divestments, etc.

RESEARCH

This is a fairly large area of public finance careers, and a lot of public finance professionals eventually become researchers.  Many large banks, government entities, and world organizations require public finance professionals to consolidate necessary data points for decision making. Thus there is a regular requirement of public finance professionals in the field of research.

ACADEMIA

A lot of public finance professionals eventually go on to become professors and teach public finance in universities and colleges. Not only limited to teaching, but they also participate in university researches to improve understanding of the field and create new tools for efficient practical applications.

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