Dr. Khurrum S.

Mughal
 Introduction to Public Finance
 Evaluating Public Finance and Role of the Government
 Public goods and Externalities
 Public Revenue
 Theories & Principles of Taxation
 Effects of Taxation
 Public Expenditure
 Theories & Principles of Public Expenditure
 Public Debt and Management

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 Public Finance and Public Choice: Analytical Perspectives,
Third Edition,
John Cullis and Philip Jones

 Public Finance: A Contemporary Application of Theory to Policy,

Tenth Edition,
David N. Hyman

 Public Finance
M. Maria John Kennedy

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Public Finance
 Public Finance, field of economics concerned
with how governments raise money, how
that money is spent, and the effects of these
activities on the economy and on society

 Also known as “public sector economics” or

“public economics.”

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 Public finance studies how governments at
all levels—national, provincial, and local—
provide the public with desired services and
how they secure the financial resources to
pay for these services.

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 In many industrialized countries, spending
and taxation by the government form a large
portion of the nation's total economic
activity.
 For example, total government spending in
the Pakistan equals about 20 percent of the
nation's gross domestic product

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 The Functions of The State

 The Effects of Fiscal Operations on Economic Life

 The Subject Matter of Public Finance

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The Functions of the State
 Set common rules of behavior
 Protect citizens from external threats
 Pool resources for the common good
 Intervene in the system since Individuals may
be unable to evaluate utility of certain
products
▪ Elementary Education for children

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 Address and correct market failures
▪ To provide the institutions that allow market to function

(e.g. protection of property rights)

▪ To provide the essential goods and services that markets

fail to adequately provide

▪ Regulating the behavior business entities

▪ Monopoly Control Authorities

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 Society is a natural organism
 Goals of society set by state
 Actions of individual are judged by the
contribution they make to the state
 “Ask not what your country can do for you;
ask what you can do for your country.”
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 Individuals are paramount, government
created to meet the needs of individuals
 Big debate over importance of individual
freedom
 Two types of freedom:
▪ Freedom to do as you like
▪ Freedom not to suffer from activities of others
▪ As society grows more crowded, second type of
freedom becomes more important

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• Government is comprised of thousands of
government units
• Three levels:
• Federal

• Provincial

• Local

• Each level allocates different levels and types

of resources
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 Size of the Government
▪ Number of government employees
▪ Annual expenditures

 Role of the Government

▪ Free market ideology

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The Effects of Fiscal Operations on Economic Life
 Governments provide public goods—
government-financed items and services such
as roads, military forces, lighthouses, and
street lights.
 Private citizens would not voluntarily pay for
these services, and therefore businesses have
no incentive to produce them.

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 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.

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 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.

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 Public finance provides government
programs that moderate the incomes of the
wealthy and the poor.
 These programs include social security,
welfare, and other social programs.
 For example, some elderly people or people
with disabilities require financial assistance
because they cannot work.

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 Governments redistribute income by
collecting taxes from their wealthier citizens
to provide resources for their needy ones.
 The taxes fund programs that help support
people with low incomes.

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 Taxation
 Protection to Infant Industries
 Providing Employment Opportunities
 Economic Planning
 Equality
 Economic Stability
 Optimum Utilization of Resources
 Savings and Investments
 Subsidies and Grants
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 Government spending and taxation directly affect
the overall performance of the economy.
 For example, if the government increases spending
to build a new highway, construction of the highway
will create jobs. Jobs create income that people
spend on purchases, and the economy tends to
grow.
 The opposite happens when the government
increases taxes. Households and businesses have
less of their income to spend, they purchase fewer
goods, and the economy tends to shrink.

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The Subject Matter of Public Finance
 Public Expenditure
 Public Revenue
 Fiscal Policy
 Public Debt

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 Each year national, Provincial, and local
governments create a budget to determine
how much money they will spend during the
upcoming year.

 The budget determines which public goods to

produce, which spillovers to correct, and how
much assistance to provide to financially
disadvantaged people.
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 The chief administrator of the government—such as
the prime minister, governor, or mayor—proposes
the budget.
 The legislature—such as the parliament, Provincial
council, or Municipality council—ultimately must
pass the budget.
 The legislature often changes the size and
composition of the budget, but it must not make
changes that the chief administrator will reject and
veto.

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 Government spending takes two forms:
▪ Exhaustive spending
▪ Transfer spending.

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 Exhaustive spending: refers to purchases
made by a government for the production of
public goods.
 For example, to construct a new harbor the
government buys and uses resources from
the economy, such as labor and raw
materials.

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 Transfer spending when government transfers
income to people to help them support themselves.

 Transfers can be one of two kinds i.e. cash or in-

kind.
▪ Cash transfers are cash payments, such as social security
checks and welfare payments.
▪ In-kind transfers involve no cash payments but instead
transfer goods or services to recipients. Examples of in-
kind transfers include food stamp coupons and Medicare.

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 Governments must have funds, or revenue, to
pay for their activities.

 Governments generate some revenue by

charging fees for the services they provide, such
as entrance fees at national parks or tolls for
using a highway.

 However, most government revenue comes

from taxes, such as income taxes, capital taxes,
and sales and excise taxes.
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 An important source of tax revenue in most
industrialized countries is the income or payroll tax,
also known as the personal income tax.

 Income taxes are imposed on labor or activities that

generate income, such as wages or salaries.

 In the United States, income taxes account for

about half of the total revenue of local, state, and
federal governments combined.
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 Another important source of government revenue is the
capital tax.
 Capital includes items or facilities that generate profits,
such as factories, business machinery, and real estate.
 Some types of capital taxes are known as “profits” taxes.
 One kind of capital tax used by the federal government is
the corporate income tax.
 A property tax is a capital tax used by state and local
governments. Property taxes are levied on items such as
houses or boats.
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 Sales and excise taxes are also a major source of
government tax revenue.
 Many state and local governments levy a sales tax
on the purchase of certain items.
 Consumers usually pay a percentage of the sales
price as the tax.
 Excise taxes are used by all levels of government.
 An excise tax is levied on a specific product, such as
alcohol, cigarettes, or gasoline.
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 A government's fiscal policy is the way the
government spends and taxes to influence
the performance of the economy.

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 When the government spends more than it
receives, it runs a deficit.
 Governments finance deficits by borrowing
money.
 Deficit spending—that is, spending funds
obtained by borrowing instead of taxation—
can be helpful for the economy.

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 when unemployment is high, the government can
undertake projects that use workers who would
otherwise be idle.
 The economy will then expand because more
money is being pumped into it.
 However, deficit spending also can harm the
economy.
 When unemployment is low, a deficit may result in
rising prices, or inflation. The additional government
spending creates more competition for scarce
workers and resources and this inflates wages and
prices
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 Allocation Function

 Distribution Function

 Stabilization Function

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 Allocation Function
▪ Allocation of total resources between private goods and
social goods

▪ Choosing the mix of social goods

▪ Taxation and spending as major instruments

▪ Importance of non-fiscal regulatory instruments

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 Distribution Function
▪ Distribution of income and wealth between various classes

▪ Taxes and subsidies as major tools

▪ Under Allocation function, taxes are used to distribute

resources between private and public wants

 Stabilization Function
▪ Influencing the unemployment, price level and output

▪ To tone down the effects of economic cycles

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 Defined Public Finance as a field of economics is concerned with
how governments raise money, how that money is spent, and the
effects of these activities on the economy and on society.
 Defined the scope of public finance under three heads
 Established the importance of the role of the government in an
economy
▪ Which has increased due to welfare role

 Established the importance of public revenue, expenditure, debt

and fiscal policy
 Highlighted the major fiscal functions.
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