By

Dr. MNAKU H. MAGANYA

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 TOPICS TO BE COVERED
1. Introduction
2. Economics of Taxation
3. Public Choice Theory
4. Taxation of Income and Wealth
5. Impact of Inflation on Taxes
6. Trade Taxes
7. Government Revenue & Expenditure
8. Government Budget & Fiscal Policy
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 1. INTRODUCTION
1.1 Subject Matter of Public Finance
1.2 Significance of Public Finance
1.3 Function of Government
1.4 Tools of Public Finance
1.5 Attitudes towards Government
1.6 Causes for Market Failure
1.7 Causes for Government Failure
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 Subject Matter of Public Finance
Public finance is the subject that deals with the
economics of the public sector, including not only
its financing but its entire bearing on the level and
allocation of resources use (expenditure) as well
as the distribution of income in the society.
It’s the branch of economics dealing with taxing
and spending activities of government.
Economists dealing with public finance analyze
both actual policies and develop guide lines for
government activities.

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 Subject Matter of Public Finance
Scope of Public Finance
1. Public Revenue: which deals with the method of
raising funds and the principles of taxation.
classification of public revenue, canons and
justification of taxation, the problem of incidence
and shifting of taxes, effects of taxation, etc.
2. Public Expenditure: which deals with the
principles and problems relating to the allocation
of public spendings; classification and justification
of public expenditure; and expenditure policies of
the government.
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 Subject Matter of Public Finance
3. Public Debt, which deals with the study of
the causes and methods of public debt
management.
4. Financial Administration, under this the
problem of how the financial machinery is
organized and administered is dealt with.
5. Economic Stabilization, economic policies
of the government to bring about economic
stability in the country.

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 Significance of Public Finance
Importance (Significance) of Public Finance:
1. Stade State Economic Growth: Government
finance is important to achieve sustainable
high economic growth rate
2. Price Stability: The government uses the
public finance in order to overcome form
inflation and deflation.
3. Economic Stability: The government uses
the fiscal tools to stabilize the economy
during period and boom and recession.
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 Significance of Public Finance
4. Equitable Distribution: The government
uses the revenues and expenditures of itself
in order to reduce inequality.
5. Proper Allocation of Resources: The
government finance is important for proper
utilization of natural, man-made resources.
6. Balanced Development: The government
uses the revenues and expenditures in order
to erase the gap between urban and rural
and agricultural and industrial sectors.
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 Significance of Public Finance
7. Promotion of Export: The government
promotes the export imposing less tax or
exempting from the taxes or providing
subsidies to the export oriented goods.
8. Infrastructural Development: The
government collects revenues and spends
for the construction of infrastructures. It
has to keep peace, justice and security too.

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 Economic Functions of Government
Economic Functions of
Government
1. Allocative function: provide certain goods,
social or public as distinct from private
goods which cannot be provided for
through the market system.
2. Distributive function: Among various fiscal
devices, redistribution is done most directly
by a tax transfer scheme and progressive
income tax system.
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 Economic Functions of Government
3. Stabilization function: as an instrument of
macroeconomic policy, budget or fiscal
policy may be designed to maintain or
achieve the goals of high employment,
reasonable degree of price stability,
soundness of foreign reserve.
4. Regulative and Coordination function:
unfair advantage of workers prevents
business from taking advantage of
consumer ignorance.
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 Tools of Public Finance
Positive and Normative Economics
The dual tasks of economists are to explain how
the economy works-positive economics and to
determine whether or not it’s producing good
results-normative economics.
In principle positive analysis does not require
value judgments, because its purpose is
descriptive.
Normative analysis on the other hand, requires an
ethical framework, because without one, it’s
impossible to say what is good.
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 Tools of Public Finance
Recall that Public Finance is the study of
how governments collect and spend money
and real resources
How do governments collect/spend
money? Positive analysis
How should governments collect/spend
money? Normative analysis
We are studying public finance in a market
economy

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 What is the Role of Government?
To maintain and improve the welfare of
the people
To protect the people from harm
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

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 Attitudes towards Government
Public finance economists analyze not only the
effects of actual government taxing and spending
activities but also what these activities ought to
be.
1. Organic View: Society is conceived as a natural
organism. Each individual is part of this organism,
and the government can be though as its heart.
2. Mechanistic View: In this view, government is
not an organic part of society. Rather, it is a
contrivance created by the individuals to better
achieve their individual goals.
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 Causes of a Market Failure
Market failure may occur in the market for several
reasons, including:
1. Externality: refers to a cost or benefit resulting
from a transaction that affects a third party that did
not decide to be associated with the benefit or cost.
2. Public goods: Public goods are both non-rivals as
well as non-excludable.
3. Market control: Market control occurs when
either the buyer or the seller possesses the power to
determine the price of goods or services in a
market.

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 Causes of a Market Failure
4. Asymmetric information in the market:
Market failure may also result from the lack of
appropriate information among the buyers or
sellers.
5. Common Property Resources: Common
ownership when coupled with open access, would
also lead to wasteful exploitation.
6. Incomplete markets: Markets for certain things
are incomplete or missing under perfect
competition, public goods and common property
7. Public Bads: air and water pollution
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 Solutions to Market Failure
During market failures the government usually
responds to varying degrees. Possible government
responses include:
1. Legislation: Enacting specific laws.
2. Direct provision of merit and public goods:
governments control the supply of goods
that have positive externalities.
3. Taxation: placing taxes on certain goods to
discourage use and internalize external
costs.
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 Solutions to Market Failure
4. Subsidies: reducing the price of a good
based on the public benefit that is gained.
5. Tradable permits: permits that allow firms
to produce a certain amount of something,
commonly pollution.
6. Extension of property rights: creates
privatization for certain non-private goods
like lakes, rivers, and beaches to create a
market for pollution. Then, individuals get
fined for polluting certain areas.
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 Solution to Market Failure
7. Advertising: encourages or discourages
consumption of merit goods and harmful
products. This should reduce marginal
damage caused in the economy.
8. International cooperation among
governments: governments work together
on issues that affect the future of the
environment.

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 Causes of Government Failure
Government Failures- it’s the limitation of
government in achieving its goals.
1. Limited control over private market responses-
Legislation are being enacted but government
have limited control on its reaction.
2. Limited control over bureaucracy- system failure
from legislation to implementation of government
project.
3. Limitation imposed by political processes-
political process through which decisions about
actions are made would raise additional
difficulties.
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 Causes of Government Failure
4. Lack of incentives: In the public sector, there is
limited or no profit motive. Because workers and
managers lack incentives to improve services and cut
costs it can lead to inefficiency. The government may
be reluctant to make people redundant because of the
political costs associated with unemployment.
5. Poor information: politicians may have poor
information about the type of service to provide.
Politicians may not be experts in their department
but concentrate on their political ideology.

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 Causes of Government Failure
6. Political interference: Decisions made for short-
term political gain rather than sound economics, e.g.
keep on unproductive workers. e.g. politicians may
take the short-term view rather than considering the
long-term effects
7. No consistency: Change of government often leads
to change of approach and new political initiatives
8. Moral hazard: The government may offer a
guarantee to all bank deposits to protect the financial
system, but this could encourage banks to take risks –
because they know they can be bailed out by the
government.
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 Overcoming Government Failure
There are various things the government
can try and do to overcome government
failure:
1. Give performance targets/profit incentives
to different government owned institutions
and agencies.
2. Competitive tendering where public sector
bodies face competition from the private
sector for the right to run a public service.

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 Overcoming Government Failure
3. Employing outside private sector
consultants to make decisions about how to
cut costs.
4. Delegating certain decisions to non-
political bodies. For example, setting
interest rates was given to the Bank of
England as politicians often set interest
rates for political reasons. (Central Bank
independence)

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 THANK YOU
FOR
YOUR ATTENTION!!!

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