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11 ‘Introduction, 1.2. Meaning of Public Finance, , 1.3. Scope of Public Finance, 1.4 Fiscal Operational Areas, 1.5. Fiscal Functions, , SS, The Governments in almost all countries play an important role,, directly or indirectly, in promoting economic growth. Adam Smith, and other classical economists wanted the government! to confine, its activities to defence, law and order and social activities like health, and education. They believed that a government which spends, public (citizens) money, not its own, tends to be generous and casual, , _ in its spending. Hence the classical economist did not want the, government to get involved in such economic activities which the, market can handle efficiently., , , , 1, Important classical economist who advocated market economy were Adam, Smith, David Ricardo, Robert Thomas Malthus and James Stuart Mill, all, English economists of 18th and 19th centuries.

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Business Economics-IV (S. Y.B.Com. : SEM-IV), , «on of Soviet Socialist Republics) which, tn 20th cenary, USS ince 1917 and China since 1950s, based, included raat advocacy of collective ownership of means of, on Karl. er roletariat to overcome exploitation of poor by the, , ee oh market economy, introduced socialism/, ane their countries. These economies, where the State/, cmeeeat cocerolled means of production, decided all the, Sune activities, that is, production, exchange, distribution and, consumption. The Russian system collapsed by 1990 and China, initiated many economic reforms in the post 1990s. According to, the critics, Russian and Chinese economies could not function well,, as the exploitation by capitalist through market economy was, , replaced by the exploitation by the State., , Many other countries, including India, — - square —, system, ad England during the 19th an century. Under, the orcad governments attempted to control and regulate, their economies besides, directly undertaking some of the important, economic activities. India provided the best example of a mixed, economy where it controlled ‘commanding heights' of the economy, through public sectors. By the last quarter of the 20th century, the, public sector undertakings in these economies, specially in India,, according to critics, had become 'white elephants’. During 1990s most, of the economies including India, liberalised their economies by, encouraging and promoting private sector,, , Governments, however, could not abdicate its economic role, completely. Market failure (refer Chapter-3) in providing public, goods and tendency to exploit consumers through markets,, compelled the governments to play a positive role by providing, public goods (refer Chapter 3). To enable it to perform its role, it, applies the required policy measures such as monetary, fiscal,, industrial, trade and exchange rate policies. For a better control and, functioning of the economy, institutions like Central Banks (RBI in, India) and other regulatory institutions were established. In India,, besides RBI, we have other regulatory institutions like Securities, a ironieen Board of India (SEBI), Insurance Regulatory and, lopment Authority (IRDA), Real Estate Regulatory Authority, (RERA) to regulate the different activities in the economy and protect, the consumers from exploitation. !, , The Role of Government in an Economy - Public Finance 3, , Democratic governments make use of fiscal policy to raise revenue, and incur expenditure in order to achieve its economic objectives, and at the same time enable the economy to function smoothly., , We, in this book, will discuss the various aspects of Public Finance., , Classical and neo-classical economists discussed public finance in, the context of money raising and money spending activities of the, government. Adam Smith, David Ricardo and John Stuart Mill, individually provided insights into public revenue, public, expenditure and public debt, though they did not provide any logical, and precise definition of public finance. One of the first books, exclusively written on the subject was by Bastable if. 1892, According, to Bastable, “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.”, , In 1922, Hugh Dalton published Principles of Public Finance. This, was followed by A.C. Pigou’s A Study in Public Finance in 1928., According to Hugh Dalton, “public finance is concerned with the, income and expenditures of public authorities and with the, adjustment of one with the other.”, , Some other definitions of public finance are given below :, , Otto Eckstein - German American Economist (1927-1984), “public, finance is the study of the effects of the budgets on the economy,, particularly the effects on growth, stability, equity and efficiency.”, , Philip E. Taylor - University of Connecticut (1908-1975), “public _, finance deals with the finances of the government. The finances of, , the government include raising and disbursement of government, , funds,", , Ursula Hicks - Irish Economist (1896-1985), "the main content of, , public finance consists of the examination and appraisal of the, , methods by which government bodies provide for the collective, , satisfaction of wants and secure necessary funds to carry out their, , purposes."

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Business Economics-IV (S.Y.B.Com. : SEM-IV), , i Richard ave!, "public finance is concerned with, ena centre ee revenue - expenditure, process of government." However, "the basic problems arenot issues, of finance. They arenot concerned with money, liquidity or capital, markets. Rather, they are problems of resource allocation, the, distribution of income, full employment, price level stability and, growth.” ., , From the above definitions itis clear that the subject matter of public, finance includes public revenue, public expenditure, public debt and, financial administration., , The classical and the neo-classical economists generally confined, the study of public finance to the narrow area of government's, financial activities only. They also believed that government, intervention in the economy should be kept minimal. But under the, socialistic system, the role of the State extended to every aspect of, people's lives. Again, during the Great Depression of 1930s that hit, the US economy, it became clear that the classical policies of laissez, faire i.e, minimal state intervention in the economy could lead to, failure of market mechanism. Problems of unemployment and, poverty during the depression made it necessary for the US, government to expand its activities to revive the economy., , John Maynard Keynes, in his General Theory of Employment,, Interest and published in 1936 emphasized for the first time, that the role of State needed to expand when the markets failed to, correct themselves. He advocated that the financial or fiscal, operations of the government can be used to remove distortions in, the economy. The financial operations could be used to influence, the level of aggregate demand and employment. The public budget, could be used to mobilise resources for rapid growth, balanced, development and social justice. These policies were successful in, reviving the US economy from the Great Depression and have been, widely followed by most market economies since then, giving rise, to the concept of Functional Finance., , Public finance deals with not onk i i ernumy, a ly the way_in which thi t, operates, italso deals with the repercussions of the different policies, , 4, , , , 1. Richard Musgrave, American Economist, 1910-2007,, , The Role of Government in an Economy - Public Finance 5, , which the government might ado i, t : pt and accord: i, question of choice of these policies and peers ioe, , Two important concepts associated with blic finance i, policy; and (ii) budgetary policy. i nner, , (i) Fiscal Policy is the part of government policy that deals with, Taising revenue through taxation and other means and deciding, on the level and pattern of public expenditure. It is composed, of tax policy, expenditure policy, investment or disinvestment, Strategies and public debt management. In most modern, economies, the government deals with fiscal policy while the, central bank is responsible for monetary policy., , (ii) Shae ene A policy refers to government's strategies to, implement and manage a budget. It is a more specific poli, than fiscal policy, . eat, , In a narrow sense, public finance is the branch of economics which, deals with the financial activities of the government at national,, state and local levels. However, in a broader and currently used, approach, the study of public finance is used to understand and, analyse the role of the State in the economy., , Classical economists advocated minimal role of the government., They defined public finance as a part of political economy that deals, with revenue and expenditure of the government. Before the Great, Depression of 1929, most governments of capitalist nations followed, the laissez faire economic policy, under which the functions of the, governments were restricted to protecting the country from external, aggression, maintaining law and order, administering justice and, providing basic amenities to the people. During this period, the role, of public finance was limited to raising funds for the above functions., Economists believed that public expenditure should be kept to the, minimum and taxation should be limited to what is necessary to, fulfil the basic public expenditure. Governments should follow, , balanced budget wherever possible.

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Business Economics-IV (S- Y.B.Com. : SEM-IV), D Great Depressi! the period that followed it, the, ae eed naa connge Most developed, ; jes became states. It was felt that the budget, ea very oan tool to correct instabilities like, depression inflation. Durin, depression, economists advised, oer follow deficit budget and during inflation to follow, Jus budget. By raising public expenditure during depression, aan aggregate demand can be raised and this will revive, the economy. On the other hand, during inflation, public expenditure, can be reduced and taxes can be raised to reduce money supply and, purchasing power. This is referred to as functional finance., , [EAGSCAL OPERATIONAL AREAS), , The scope of public finance is extended to the following fiscal, operational areas through the instrument of budget. The important, , areas are:, , 1. Public Revenue : It is the means for public expenditure. The, necessity of raising the public revenue follows from the, necessity of incurring public expenditure. Public revenue deals, with the methods of raising income from tax and non-tax, sources. In this connection we study the principles of taxation,, incidence of taxation and the effects of taxation. Since tax, revenue can be raised from both direct and indirect taxes, we, also study the relative merits and demerits of direct and indirect, taxes. Since non-tax revenues consist of surpluses of public, enterprises, public borrowing and deficit financing, we also, study about the methods of raising revenues through these, sources., , ) 2 Public Expenditure : It refers to the expenses of public, authorities - central, state and local governments. Public, expenditure is a major tool for implementing various policies, of the government with respect to welfare, growth, stabilization, anso on. Thus, public expenditure occupies an important place, in the study of public finance. In this connection we study the, — of public expenditure, justification for various kinds, public expenditure and effects of public expenditure. We also, , The Role of Government in an Economy - Public Finance 7, , study the changes in the pattern of public expenditure over the, years., , Public Debt ; With the increase in the activity of the state, the, shortfalls in income of the state is frequently made up through, loans. Thus, public debt has become an important source of, revenue both in the developed and developing countries. In, modern times, borrowing by the government has become a, normal method of government finance along with the other, sources of public revenue. In all countries of the world, public, debt has shown a tendency to increase. Thus, the study of public, debt has become an integral part of public finance., , The problems relating to the raising and repayment of public, loans are studied under this part of the public finance. In this, connection we study about the sources of public loans, methods, of raising the public loans, methods of repayment of principal, amount of loan and interest, and burden of public debt., , Financial Administration : The scope and subject matter of, public finance is not confined only to the study of public, expenditure, public revenue and public debt. We also have to, examine the mechanism by which these processes are carried, out. In this context we are concerned with the organization and, functioning of the government machinery which is responsible, for carrying out the various functions. This is done by the, government through the budget., , Thus, public finance involves the study of budget which is the, financial plan of the government. The budget gives a complete, picture of the estimated receipts and expenditure of the, government during the year. In India the budget is divided, into 2 parts, that is (i) Revenue budget and (ii) Capital budget., The revenue budget deals with the receipts from taxation, public, enterprises, etc. and the expenditure incurred on the normal, running of government departments and services, etc. On the, other hand, capital budget deals with the capital receipts which, include the market loans, borrowing by government from R.B.I., etc. The Capital expenditure is the expenditure incurred for the, acquisition of assets like land, equipment, ete. for the, , development purposes.

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Business Economics-IV (S. Y.B.Com, : SEM-IV), , ing countries, the role of public finance and the, a one different. In such countries, public, expenditure is used as a means to achieve economic, development and growth, while taxation is used asa source of, financing developmental activities and bring economic justice,, , Therefore the work relating to preparation of the bud get,, presentation of the budget, passing of the budget, execution of, the budget and the evaluation of the budget is the subject matter, of public finance., , During the1930s Great Depression and in the post 1950s the scope, and functions of public finance has undergone a sea change., , The state is no more confined to essential activities prescribed by, classical economists. Besides the traditional activities, the role of, the government, today, is extended to promoting economic growth,, reducing inequality of income, irradicating absolute poverty and so, on. In brief, the present day governments are expected to bring, positive economic and social changes. Accordingly they require to, spend a huge amount of money. In developing economies, like India,, the role and responsibilities of governments are multifarious. Public, finance as an instrument to deal with the above tasks., , The classical idea of 'Sound Finance’ was no more popular. Budget, asan instrument of public finance is used to achieve many economic, objectives,, , At present all the governments through the budget and fiscal, operations aim to discharge the following functions., , (a) Allocation of resources: The most im rtant ol jective of fiscal, operations is to determine how the ei eS will be, allocated to different sectors of the economy in order to achieve, predetermined goals. Allocation of resources depends upon the, collection of taxes and size and composition of government, expenditure. The national budget determines how funds are, , The Role of Government in an Economy - Public Finance 9, parser to different heads of expenses. The policy of public, expen a is used by the government to directly undertake, , Tesource allocation for different sectors. On the other hand, the, , : ‘axation and subsidies to indirect!, influence resource allocation. The market mechanism cunne, , provide all goods and services for the Satisfaction of ‘collectiv:, , n . e, wants” through public goods like defence, justice and security., The government has to adjust between allocation of resources, for the provision of public goods and private goods., , In India, the central government through its annual budget, allocates expenditure to different sectors and sub-sectors. These, sectors include the essential activities like defence, law and, order, justice and other essential social activities such as, education and health, as suggested by classical economists, but, also various developmental activities connected to agriculture,, industries and service sectors. Private investment is promoted °, or discouraged through positive and negative incentives., , (b) Distribution : Fiscal operations can be effectively used to affect, the distribution of national income and resources. Taxation and, public expenditure policies are used by the government to, reduce inequalities. Progressive direct taxes impose heavier, burden on the rich than the poor. Public expenditure on social, infrastructure and subsidies on food, housing, health and, education help reduce income inequality., , India’s direct tax system is progressive where tax rates range, from 5 percent to 30 percent plus surcharge. The newly, introduced Goods and Services Tax (GST) is also varies, depending on the nature of goods and services. The GST ranges, from 5 percent to 28 percent. Essential goods and services are, either exempted from the GST or taxed at a low percent., Through the budget, Goverriment of India spends money to, provide ‘Food Security’, health care and employment to the, poorer sections of the society. The state governments too have, introduced many welfare schemes to reduce the inequality of, , income,, , 1. Musgrave Richard A,, The Theory of Public Finance ; A Study in Public, Economy, McGraw-Hill Book Co,, 1959.