Study of Public Finance

Significance and scope of government involvement in economic decisions depends upon the political ideology of government structure and roles to a great extent. History has revealed that there have been three types of economic systems.

In a capitalistic economy economic decisions (and thereby the economic activities) are done by the private sector. Each economic unit operates in accordance with the economic rationality being guided by the market mechanism with an objective of income maximizing criteria. In such system government has only limited role, mainly as the facilitator and regulator.

A communist (controlled) economy is dominated by the state where economic decisions and activities would not be guided only by the economic maximizing criteria. Market mechanism is assigned a marginal role. 

In a mixed economy there is the co-existence of both the private and public sectors in economic activities. Government is to perform the role of an investor, facilitator and regulator. However, in modern times, almost all countries have mixed economy where the scope and involvement of public and private sector may vary. It is fairly common to justify the need for and presence of government involvement and intervention in economic activities besides the fundamental (basic) functions.

Public sector economics or Public finance deals with the questions of collective wants (i.e. the wants of the community as a whole) and their satisfaction. Public finance aims at maximizing social welfare or social benefits by efficient use of social goods. Collective wants are those which are demanded by all members of the community in equal or, more or less equal measure. Defense, education, public health, infrastructural facilities like power, transportation and communications, etc. are examples of the collective wants. Goods and services produced to satisfy collective wants are known as social goods. The features of social goods are: 
  • Social goods are not divisible;
  • There is some compulsion in providing social goods; and
  • There is no exclusion in social goods.
The grounds for state involvement and interference in economy are: 
  1. Distortions in production structure and failure to create reasonable employment by market mechanism;
  2. Need for the maintenance of economic stability with control of trade cycles (mainly in the developed countries); and
  3. To promote the rate of economic growth and distributive justice {mainly in the developing countries).


“The term public finance has come by accepted usages, to be confined to a study of funds raised by governments to meet the costs of government.” - Carl C. Plehm

“Public finance deals with the income and expenditure of public authorities, and the manner in which one is adjusted to another.” - Dalton

“Public finance is the study of the principles underlying the spending and raising fund by government”. - Findlay Shirras

“Public finance deals with the finance of the public as an organized group under the institution of government. It thus deals only with the finance of government. The finances of the government including the raising and disbursement of government funds.” - Bastable

“The complex of problem that center around the revenue - expenditure process of government is referred to traditionally as public finance. While operations of public household involve money flows of receipt and expenditure, the basic problems are not the issues of finance. We must think of our task as an investigation into those aspects of economic policy that arise in the operation of the public budget.” - Musgrave

“Public finance is a field of inquiry that treats the income and outgo of governments. In modern times, this includes four major divisions: public revenue, public expenditure, public debt and certain problems of the fiscal system as a whole such as fiscal administration and fiscal policy.” - Harold Grooves


The nature and scope of public finance has been changing with the changes in the nature and scope of governmental activities as per the need of the economy (society). The scope of governmental activities is to a great extent by the political ideology of the state/government.

In broad sense, the nature of public finance may be categorized as the neutral or non-regulatory and regulatory, mainly on the basis of interfering and influencing the economy. The nature and scope in different periods is determined being guided by different theories.
  1. Pure theory of Public Finance (1776-1880’s): Early classical economists like Seligman, Say, Ricardo advocated the scope of public finance limited to the study and analysis of only the operation of the treasury just for performing the minimum necessary activities by government without any considerations of welfare concept.
  2. Socio-political Theory (1880’s-1930): The neo-classical writers like Wagner, Marshall, Pigou, Edgeworth advocated the social welfare considerations to included in the scope of public finance.
  3. Functional finance Theory: Since 1930’s depression, Keynes, Dalton, Lerner, Hansen like economists advocated government involvement and interference in the economy as per the necessity for maintenance of economic stability, and thus, the nature of public finance being a regulatory one.
  4. Activating finance theory: After the Second World War {mainly since 1d950’s), with the concern about economic development of the developing countries, public finance is to activate the economy with the government involvement as an investor, facilitator and regulator.


  1. Allocation function: It is concerned with the use of economic resources on what type of goods and services’ production with the objective of growth promotion as well as whether to produce in the public sector or private sector.
  2. Distribution function: It is concerned with the distribution of national income in n equitable way as accepted by the society, mainly to promote the distributive justice.
  3. Stabilizing function: It is concerned with the maintenance of economic stability with the control of economic fluctuations, inflation and correction of adverse balance of payments (BOP).


The subject matter of public finance is the areas of study in relation to the operation of the treasury and the repercussion of different policies operated by the treasury. The subject matter includes:
  1. Public Revenue:- Includes the concept of government revenue and tax, principles of taxation and its effects and role in the economy.
  2. Public Expenditure:- Includes the study of the concept, principles underlying the allocation of public expenditure, and its effects in the economy.
  3. Public Debt:- Includes the study of the concept, sources, need, burden and principles of public debt management.
  4. Financial Administration:- Includes the study of the concept, theories and process of government budgeting.
  5. Fiscal Policy:- Includes the study of mainly the concept and the use and adjustments of the public financial instruments to achieve the desired economic objectives like economic stability, growth and distributive justice.

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