Public finance is not
a new field of study. It dates from emergence of governments which means that
it is not
as old as
governments. From time immaterial, governments imposed taxes to raise enough
revenue only to
cover the cost of
administration and defence. The state is supposed to provide security and
prohibit or
regulate those
activities by individuals or by groups within the society which might injure
the community as a
whole.
To provide for these
necessary services, government began to raise money in form of taxes. This is
why taxes were
regarded as payment for services rendered by the government. Today, the number
of
services which the
governments provide have increased tremendously. Government development
expenditure,
roads and equipment
required to provide government social and economic services.
Since independence in
1960, the government has sought to control the level of economic activity by
alterations in fiscal
policy, and it has used monetary policy mainly to create the general economic
atmosphere.
“Public Finance” is
the term applied to the study of the methods employed by the government to
raise
revenue, and the
principles underlying Government expenditure.
It is important to
understand that Government expenditure is just as much as part of public
finance as
adjustments to
taxation.
In order to emphasise
this, we shall in this unit examine the expenditure side of government before
investigating
the main sources of
revenue and later examine the role of fiscal policy in the next unit.
Meaning of Public Finance
Public Finance refers
to that branch of economics that is concerned with the revenue, expenditure and
debt
operations of the
government and the impact of these measures. It identifies and assesses the
effects of
governmental
financial policies. That is it tries to analyse the effects of government
taxation and other
sources of revenue
and expenditure on the economic situations of individuals, institutions and the
economy as
a whole. It develops
techniques and procedures to increase that effective in effect, it looks into
the financial
problems and policies
of the government at different levels and studies the inter-government
financial relations.
Public finance can be
defined from two major perspectives. Firstly, Public Finance can be defined
from
the perspective in
which finance is defined as money. If this view is held, then Public Finance as
a technical
term would refer to
the pool of resources (borrowed or earned) available to government for the
satisfaction
of public wants. As a
course of study, public finance can be defined as that part of economics that
deal with
the economic behavior
of governments. It discusses the various ways by which the government carries
out
its allocative,
redistributive and Stabilization functions in the economy. This will include
government taxing,
spending, borrowing,
transfers, aids subsidy and other operations that pertain to the use of scarce
resources
of government.
In common usage, the
term public finance means the financing of the government including the
economics
of finance as well as
the social effect and consequences of government policies. Public Finance can
equally
be called the study
of public sector economics. It is an aspect of economics which deals with
government
revenue and
expenditure.
The study of public
finance involves a detailed analysis of the various sources from which the
government
derives its income,
the items on which the government spends its money and the impact of such
government
revenue sources and
government expenditure on different aspects of the economy.
Distinguish between Public Sector and Private Sector of the Economy
It is usually
necessary to look at the economy from the point of view of the degree of
influence and economic
resources of the
government and of individuals. In this context, we are talking of public and
private sectors of
the economy.
Public Finance is
described as that branch of economics which studies the economic behavior of
governments.
Economics itself is
the study of man making decision in a world where scarcity of resources
relative
to human wants makes
choice a necessity. Economists have broadly divided the economy into two
related
sectors. i.e.
(a) Private Sector
and
(b) Public Sector
Though the end
problem in both sectors are the same, that is, the satisfaction of human wants,
their
behavior and decision
making processes vary. Hence their separate treatment in economic analysis.
The public sector
refers to all production that is in public hands. That is, in public sector,
the organization
that produces goods
and services is owned by the state. It is thus a combination of control,
government, state
government, local
authorities, the nationalized industries, public corporations, government
administration, defense and similar public service, including commercial and
non-commercial undertakings of the government.
Some public sector
activities are in the form of “nationalized industries” put differently, this
sector is that
portion of the
economy whose activities (economic and non-economic) are under the control and
direction
of the
Federal/State/Local Government.
The private sector
refers to that part of the economy not under direct government control. It
entails all
production that is in
private hands. There, the organization that carries out the production is owned
by households
or other firm. Beyond
the productive activities of private enterprises (the sole Proprietorship,
Partnership,
Private Limited
Liability Company, Public Limited Company and Cooperative Societies), the
private
sector also includes
the economic activities of non-profit-making organization and private
individuals. Put
differently, this
sector is that part of an economy whose activities are under the control and
direction of nongovernmental economic unit such as households and firms.
Modern private
economy is market oriented and operates on the principles of economic
efficiency consumer
preference and market
exclusion. This implies that resources should flow to where they are most
economically
efficient and are appropriately rewarded. Price mechanism rations the scarce
goods to the
consumers whose
preferences are expressed through the market forces of demand and supply. Thus
the
problem of relative
scarcity is solved by excluding buyers who cannot buy and sellers who cannot
sell at the
market price.
Modern public economy
on the other hand organises its own want satisfying activities on the budget
instead of the
market. Though the budget contains the priority list of public goods, the
solution to the problem
of scarcity is
determined by the political system.
Objectives /Functions of Public Finance
Traditionally, public
finance serves three major functions: Allocation, Stabilization and
Distribution functions.
(a) Allocation
function of Public Finance
Public Finance,
traditionally ensures the provision of special goods as well as ensures that
total resources
use is divided
between social and private goods. It also ensures a proper mix of social goods
provision.
Through its Public
Finance activities, government allocates the productive resources of government
to their optimal use.
It determines for instance how much of the resources should go to the
production
of consumer or
producer goods. Besides and very importantly, the government ensures that
resources
are allocated to the
production of public goods (social goods) which otherwise would be neglected by
the market system.
(b) Stabilization
function of Public Finance
Public Finance is a means
traditionally used to maintain price stability, high employment, high and
sustainable economic
growth and favorable balance of payments.
Government through
its public finance activities aim at removing or reducing such fluctuations so
that
growth can be
achieved without serious unemployment and inflation. Every government wants to
have
a stable economy.
Stability here implies stable prices at full employment. Inherent in the
economy are
forces which could
cause fluctuations and thus engender unemployment and stagnation on one hand
and inflation and
balance of payments disequilibria on the other.
(c) Distribution
Function of Public Finance
Public Finance was
also used traditionally to promote equality in income and wealth distribution.
This was to ensure
the attainment of what society see as a “just or fair” state of distribution in
(Musgrave
and Musgrave 1989).
The market system
guided by the principle of economic efficiency equates the price of a factor
with
the value of its
marginal product. This system breeds in equalities in income distribution.
Through its
public finance
activities, government tries to change the market distribution so that a higher
level of
equality can be
achieved e. g. Government can also use tax revenue to finance the provision of
the
social goods free of
charge. Examples include free Primary Education, free Primary Health-Care
delivery, etc., which
usually benefit the lower income earners.
Public and Private Goods
A proper
understanding of the meaning and scope of public finance will benefit greatly
from the knowledge
of the existence of
public and private goods, the difference thereof, and the corresponding roles
of private
and public
institutions in supplying them. Broadly, goods and services consumed in a given
economy are
divided into two viz:
(i) Public Goods
(ii) Private Goods
Goods are said to be
o f a public nature if they have the following characteristics:
(1) Indivisibility: The use of such
commodities is not divisible in the sense that each individual has access
to the entire amount
of the commodity under consideration, and the enjoyment of that commodity under
consideration by one
person does not diminish its availability to other persons. For instance,
several
persons tune into a
particular radio programme without reducing the availability of the programme
to
several other
persons.
The major problem
associated with indivisible goods is that the cost of producing or supplying
them
cannot be met
voluntarily through the price mechanism. Since the financing of such goods/services
is
by public expenditure
and not through price mechanism, their production supply must be in the hands
of
the public sector.
(2) Neighborhood
Effects: This is variously referred to as spillover effects, third party
effects of externalities
constitute an
integral part of the qualities of pure public goods. By neighborhood effects,
we
mean the economic
effects on other parties arising from production use of the good. These
externalities
can be either
positive or negative i. e. economic gain or economic loss.
(a) Non Market
externalities and
(b) Market
externalities
For instance, the
benefits of a new Federal highway cannot easily be proportioned. Also the
economic
hazards associated
with the environmental pollution which results from locomotive aim service
cannot easily be
apportioned.
(3) Zero Marginal
Cost: The
Marginal cost of a pure public goods tends to analysis of almost zero. This
means that the
inclusion of one more members of the society as a beneficiary of the said good
does not
appreciably increase
the total cost.
(4) Decreasing
Average Cost: A pure public good is expected to be subject to the law of
decreasing
average costs. By
this, we mean that as more of a given public goods is provided, the average
limit cost
decreased because of
the economics of scale.
Private Goods are said to be purely
private if they have the following characteristics:
1 . Product
Divisibility
This characteristic
requires that the availability and use of this good can be decided on a
discriminatory
manner through the
price mechanism. This means only those who can afford the price and are willing
to pay can have use
of the commodity. Others who cannot pay the price or who are not willing to pay
the price are
excluded from using the product/service. In this way, the product/service is
divisible as far
as its use is
concerned. Hence everybody does not have equal access to the use of the goods.
The
essential elements of
this characteristic are:
(i) The ability to
price the good
(ii) The divisibility
of the good
(iii) The exclusion
principle
The presence of all
these elements in a good/service makes it possible for one to voluntarily pay
for
the supply of it
because those who do not pay will not be supplied. Hence, through the market
forces of
demand and supply,
the consumers can determine the volume of any of the said goods that can be
produced.
2 . Economics of
Scale
Pure Private goods
yield favorably to the concept of large scale production. This will lead to
decreasing
average cost.
Public Revenue and Public Expenditure
Public revenue or
fund, it meant all moneys received for the interest of the whole economy. Every
citizen has
right to it. Because
government is the custodian of public wealth and welfare, it has the
responsibility to
collect such revenues
for the public. Generally public revenue is divided into two as follows:
(a) Revenue Receipts
and
(b) Capital Receipts
(a) Revenue Receipts:
This
refers to all revenues accruing to the public through tax and non-tax sources
other than all forms
of borrowing. Revenue receipts are therefore generally classified into two viz:
(i) Tax revenue and
(ii) Non-tax revenue
For tax revenue,
government generates a large proportion of its revenue from tax. For non-tax
revenue,
this is the
collective name for the revenue generated from all non-tax sources of revenue
other
than borrowing. This
will include fees, fines and penalties as well as aids and grants, profits,
interests
and dividends.
(b) Capital Receipts:
This
is the collective name for all resources of government arising from borrowings
and returns its own
lending activities. Capital receipts include borrowing from certain statutory
funds
and recoveries of
loans given to state and local governments.
The term public
expenditure is a collective name for all the monies spent by government to
maintain
the machinery of
government itself, for the benefit of the society, and the economy to meet its
obligations to
external bodies as
well as gratuities assistance to other countries.
On the basis of their
life span, expenditures are classified broadly into two viz,
(i) Recurrent
expenditure
(ii) Capital
expenditure
The term recurrent
expenditures refer to those expenditures/spending made by government for its day
by-
day operations. This
will include salaries and other emolument of workers and other monies spent to
maintain current
levels of government services such as health, education, communication, road
maintenance,
defence and internal
security. They also include transfer of payments like pensions and gratuities,
internal and
external public debt
charges. In Nigeria there have been a gradual but continuous increase in the
recurrent
expenditure of the
Federal Government.
The term capital
expenditure refers to those spending that are investments in nature. In other
words, they
are expenditure that
add to or increase the existing stock of Wealth/Capital. They are spendings on
the
provision of physical
facilities like roads, bridges, hospitals, schools, construction of dams,
communications,
mining and quarrying
outfits. In Nigeria, the capital expenditure have gradually continued to
increase perhaps
because of our
development needs.
Factors Responsible for Increased Government Expenditure in Nigeria
It was mentioned in
the last section that the size of public expenditure in Nigeria has continued
to grow.
Several factors may
be responsible for this continued rise. Among these factors are:
(1) Accelerated
development of the new Federal capital Territory in Abuja: This monumental
project
has gulped quite a
lot of money. The speed with which it was pursued in the recent past also
contributed
significantly to the
increased pressure on government expenditure on both current and capital items.
The new Federal
Capital has taken huge sums of money in terms of both capital and recurrent
expenditure.
Scope of Public
Finance 99
(2) Rising
Population: Though accurate statistics are not available because the 1989
census figures are
yet subject to adjudication,
the population of Nigeria has continued to grow at an increasing rate. In fact,
unconfirmed sources
put the current figure at an average of eighty million persons. This has
necessitated
increased government
expenditure on all items necessary for the provision of economic, social
and health serviced
to the teaming population.
(3) Infrastructural
Development: As a developing country, the need for infrastructural
development has
always been recognized
as a catalyst to our economic and industrial development. Hence, so much
money has been spent
on the provision of roads, bridges, electricity, communication facilities,
portable
water, etc.
(4) Changes in
Political and Bureaucratic Structure: In Nigeria certainly, the country’s
political and
bureaucratic
structure has undergone many changes over time. The change from a four regional
structure
to twelve-state
structure and then to nineteen, twenty one, thirty and lately thirty six has
led to huge
increase in
government spending during particular periods in which they took place. The
cost of providing
physical facilities
and other machineries for these governments at the various levels have
contributed
in no small measure
to the increasing size of the government expenditure.
(5) Campaign for
Agriculture and Rural Development: The successive administrations of the
Federal
Government have
attempted to organize programme/directorates aimed at improving agriculture and
rural development.
The expenditure of government on such programmes have been quite colossal,
some of such
programme are the Operation Feed the Nation (OFN), the Green Revolution,
Directorate
for Foods, Roads and
Rural Infrastructural (DIFFRI), Better Life and currently Family Economic
Advancement
Programmes (FEAP). The success or otherwise of these campaigns are not the
subject
for our discussion
here, the point being made is that these programmes have contributed
significantly to
the increasing
expenditures of the government.
(6) The various
programmes and organization s set up by the Federal Government to mobilize
popular
support for the
programme and activities of the ruling government has taken quite a lot from
the purse
of the government.
These agencies include the Mass Mobilization for Social and Economic Reform
(MAMSER) and the
National Orientation Agency (NOA).
(7) Inflation: The
increasing size of government expenditures can also be traced to the rising
prices of
goods, labor and
other services, indeed the inflation in Nigeria has the double digit level and
by extension
affects the level of
the public expenditure. The continuous increase in the price level means an
additional
expenditure for individuals, households and the government. Government
expenditure have to
reflect rise in
prices of goods and services, wages and salaries.
(8) Debt
Servicing: There was an extensive borrowing both internally and externally
to pursue the development
programmes. Some of
these debts have matured. The servicing of these debts (i. e. paying of
interest, due
repaying the principal sum due) has continued to add to the size of the
government expenditure.
(9) National
Crises/Wars: Such crises and wars always necessitate huge government
spending and
these partly account
for the growth. In Nigeria, the civil war and the national reconstruction
expenditure
which followed later,
contributed significantly to the growth in public spending. Also the ECOMOG,
operation in Liberia
in which Nigeria was reported to have contributed over seventy per cent of the
total
budget is a
significant factor in government expenditure growth.
(10) The idea of
planning and economic growth are being increasingly accepted by the modern
government
and this implies an
increase in public expenditure with the growing awareness of its
responsibilities to
the society. The
government started to expand its activities in the field of various welfare
measures.
Conclusion
Public Finance is
regarded as a branch of economics concerned with the finance and economic
activities of
the public sector.
Three aspects of the subject matter of Public Finance have been emphasised. The
three
aspects emphasised
include the revenue aspect, the expenditure aspect and the public debt. The
above
theory of public
finance may be broken down into two. These are:
(a) The principle of
Taxation and
(b) The principle of
public expenditure
Leading authorities
on the subject of public finance such as Musgrave and Prest tended to emphasise
the
resources allocation,
distribution and Stabilization functions of public finance.
Summary
In this unit, we have
succeeded in establishing the fact that the theory of public finance is the
theory of the
economic functions of
government; why they are undertaken, how many should be undertaken, who should
perform them and how
the resources should be provided. The classic work on this subject identifies
three
main economic
functions of government: the distribution of income, allocation of resources between
private
and public sectors,
and the Stabilization of national income. To these three functions, most people
would now
add a fourth, which
is the active promotion of economic development.
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