Chapter- One 01- Introduction -Final.pptx

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1. Public Finance(C# 306) Ch-01:Introduction Issues to be learned Concept and constituents of public finance Theories of public finance - classical theory, Keynesian theory, and Musgrave theory. Allocation and distribution – Pareto and social optimality, Pareto optimality and the competitive solution: Efficiency in consumption, Efficiency in production Good governance – Accountability and Transparency . 11/19/2023 1

2. 1.1 Understanding Public Finance 11/19/2023 2

3. 1.1 Understanding Public Finance The word public refers to general people and the word finance means resources. So public finance means resources of the masses, how they are collected and utilized and to understand the proper role of the government in the economy. Public finance is the field of economics that studies government activities and the alternative means of financing government expenditures Thus, Public Finance is the branch of economics that studies the taxing and spending activities of government. 11/19/2023 3

4. 1.2 Concepts and meaning of Public Finance 11/19/2023 4

5. Government and its Economic Role of Governments are organizations formed to exercise authority over the actions of persons who live together in a society and to provide and finance essential services. The main Role played by government in the society: To maintain and improve the welfare of the people; To protect the people from harmful activities; 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 11/19/2023 5

6. 1.2 Concepts and meaning of Public Finance In simple sense , public finance is the study of finance related to government entities. It revolves around the role of government income and expenditure in the economy. Prof. Dalton in his book Principles of Public Finance states that “Public Finance is concerned with income and expenditure of public authorities and with the adjustment of one to the other”. Prof. R. R. Musgrave, “ The complex of problems that centre around the revenue expenditure process of the government is referred to as public finance” Prof. P. E. Taylor, “ Public finance deals with the finances of the public in an organized group under the institutions of government”. 11/19/2023 6

7. Contd. So, public finance is the study of how governments collect and spend money and real resources. Public finance also analyses- How do governments collect/spend money? Positive analysis How should governments collect/spend money? Normative analysis From this definition, we can understand that public finance deals with income and expenditure of government entity at any level be it central, state or local . However in the modern day context, public finance has a wider scope – it studies the impact of government policies on the economy. 11/19/2023 7

8. 1.3 Nature of Public Finance Public finance as an art- As an art, public finance enables the concerned personnel to adopt the principles and policies in solving the financial problems of the Government in the best possible way to the maximum benefit of the society. The way to be adopted should be logical, suitable and proper according to the time. Besides, Public finance is defined as an art as it applies knowledge for obtaining various objectives. Its essential component that is fiscal policy uses knowledge of government income and expenses for achieving numerous goals like full employment, economic equality, and development. Public finance as a Science - It is referred to as a science as it systematically studies the relationship between various facts of government finance. Public finance studies the relationship between income and expenditure of the government. 11/19/2023 8

9. Contd. Public finance as a subject The scope of public finance is not just to study the composition of public revenue and public expenditure . It covers a full discussion of the influence of government fiscal operations on the level of overall activity, employment, prices and growth process of the economic system as a whole. 11/19/2023 9

10. 1.4 The scope/ constituents of Public Finance If we explain the definition of public finance, we find the the scope of public finance. Besides, Prof. Dalton classifies the scope of public finance into four areas as follows : Public Income(revenue) Public Expenditure Public Debt Public Administration (Financial) 11/19/2023 10

11. Public Income i ) Public Income public income refers to the income of the government. The government earns income in two ways – tax income and non-tax income. Tax income is easy to recognize, it’s the tax paid by people of the country in the form of income tax, sales tax, duties, VAT etc. On the other hand non-tax income includes interest income from lending money to other countries, rent & income from government properties, donations from world organizations, etc. This area studies methods of taxation, revenue classification, methods of increasing government revenue and its impact on the economy as a whole, etc. RQ – What is tax income and non-tax income of Govt ? Give example 11/19/2023 11

12. Public Expenditure ii) Public Expenditure Public expenditure is the money spent by government entities. Logically, the government is going to spend money on infrastructure, defense, education, healthcare, etc. for the growth and welfare of the country. This area studies the objectives and classification of public expenditure, effects of expenditure in different areas, effects of public expenditure on various factors such as employment, production, growth, etc. RQ :List out some recent govt. expenditure of GOB. 11/19/2023 12

13. Public Debt iii) Public debt , When public expenditure exceeds public income, the gap is filled by borrowing money from the public, or from other countries or world organizations such as The World Bank, IMF These borrowed funds are public debt. So, this area of public finance explains the burden of public debt, why it is necessary and its effect on the economy. It also suggests methods to manage public debt efficiently and effectively. RQ: Write down some good and bad effects of govt. debt in Bangladesh 11/19/2023 13

14. Public Financial Administration iv) Financial Administration- This is a more practical part of public finance. It studies the procedure to be followed by the government in imposing taxes, collecting the taxes, spending the collected money and getting the government income & expenditure audited by the competent authority . This area of public finance is all about the administration of all public finance i.e. public income, public expenditure, and public debt. Financial administration includes preparation, passing, and implementation of government budget and various government policies. It also studies the policy impact on the social-economic environment, inter-governmental relationships, foreign relationships, etc. RQ- What do you meant by public administration in PF? Explain their functions and role. 11/19/2023 14

15. 1.5 Functions of Public Finance There are three main functions of public finance as follows – The Allocation Function- The government has to perform various functions such as maintaining law and order, defense against foreign attacks, providing healthcare and education , building infrastructure, etc. The list is endless. The performance of these functions requires large scale expenditure, and it is important to allocate the expenditure efficiently. The allocation function studies how to allocate public expenditure most efficiently to reap maximum benefits with the available public wealth. However , The allocation function deals with the allocation of public goods . 11/19/2023 15

16. Contd. There are two types of goods in an economy – private goods and public goods. Private goods have a kind of exclusivity to themselves. Only those who pay for these goods can get the benefit of such goods, for example – a car. In contrast, public goods are non-exclusive . Everyone, regardless of paying or not, can benefit from public goods, for example – a road, primary education, defense 11/19/2023 16

17. Contd The Distribution Function There are large disparities of income and wealth in every country in the world. These income inequalities plague society and increase the crime rate of the country. The distribution function of public finance is to lessen these inequalities as much as possible through redistribution of income and wealth. In public finance, primarily three measures are outlined to achieve this target such as : A tax-transfer scheme or using progressive taxing , i.e. in simpler words charging higher tax from the rich and giving subsidies to the low-income Progressive taxes can be used to finance public services such as affordable housing, health care, education etc. A higher tax can be applied to luxury goods or goods that are purchased by the high-income group, for example, higher taxes on luxury cars, other luxury goods. 11/19/2023 17

18. Contd The Stabilization Function- defines 11/19/2023 18

19. Contd. Every economy goes through periods of booms and depression . It’s the most normal and common business cycles that lead to this scenario. However, these periods cause instability in the economy. The objective of the stabilization function is to eliminate or at least reduce these business fluctuations and its impact on the economy. Policies such as deficit budgeting during the time of depression and surplus budgeting during the time of boom helps achieve the required economic stability. RQ: Why is stabilization function necessary? 11/19/2023 19

20. 1.5 Key Players of Public Finance A. Ministry of Finance- the ministry of finance ( mof ), a key player in the stewardship of public finances, is responsible for government finance operations, including annual budget preparation, fiscal management, public debt management, taxation, and economic policy formulation. it oversees the operations of the country’s financial institutions, and it plans, implements, and controls the public expenditure policies and programs of the government. 11/19/2023 20

21. Contd. together with other relevant ministries and divisions, the mof is responsible for the preparation of the medium-term budgeting framework ( mtBf ) and the annual budget (both non development and development). It also develops and updates the medium-term macroeconomic framework in collaboration with the Planning commission, the Bangladesh Bureau of statistics, the national Board of revenue, Bangladesh Bank, and other relevant agencies. 11/19/2023 21

22. Contd. Economic Relations Division- The economic relations Division ( erD ) of the mof plays a key role in the overall management of external aid including loans and grants. the aDB Wing of the erD , headed by a joint secretary, is primarily responsible for selecting aDB -financed programs and projects to be included in the annual development program ( aDP ), and for maintaining the government’s overall relationship with aDB . according to the “allocation of Business” section of the Rules of Business (1996), the main functions of the erD are as follows 11/19/2023 22

23. Contd B. Ministry of Planning- the ministry of Planning oversees the financial policies of the government and is responsible for socioeconomic planning and statistical management. it has three divisions: the Planning Division; the statistics and informatics Division; and the implementation, monitoring, and evaluation Division ( imeD ). Planning Commission Implementation, Monitoring, and Evaluation Division 11/19/2023 23

24. Contd. C. Office of the Controller General of Accounts D. Office of the Comptroller and Auditor General E. Bangladesh Bank F. Asian Development Bank 11/19/2023 24

25. 1.7 Public Finance Vs Private finance 11/19/2023 25

26. 1.8 Theories of public finance Classical theory, Keynesian theory, and Musgrave theory. 11/19/2023 26

27. 1.8.1 Classical theory, The fundamental principle of the classical theory is that the economy is self‐regulating . The classical doctrine—that the economy is always at or near the natural level of real GDP—is based on two firmly held beliefs: J.B. Say's Law and the belief that prices, wages, and interest rates are flexible. 11/19/2023 27

28. 11/19/2023 28

29. 1.8.1 Classical theory, 11/19/2023 29

30. Contd. 11/19/2023 30

31. Law of Market 11/19/2023 31

32. Contd. 11/19/2023 32

33. Criticism of Classical theory The following are the main points of Keynes’ criticisms against the classical theory: Unrealistic Assumption of Full Employment Condition: Undue Importance to the Long Period- Keynes opposed the classical insistence on long-term equilibrium; instead, he attached greater importance to short-term equilibrium. Keynes’ Denial of Say’s Law of Markets- Classical economists rest on Say’s Law which blindly assumed that supply always creates its own demand and affirmed the impossibility of general overproduction and disequilibrium in the economy. Keynes totally disagreed with this view and stressed the possibility of supply exceeding demand, causing disequilibrium in the economy and pointed out that there is no automatic self-adjustment in the economy. 11/19/2023 33

34. Contd 4. Keynes’ Attack on Laissez-faire Policy- Keynes strongly attacked the classicists for their unrealistic approach to the problems of contemporary capitalist economic system. Pigou’s plea for a return to free perfect competition to solve the problem of unemployment seemed ‘obsolete’ in the changed conditions of the modern world. 5. Attack on Money Wage Cut Policy- Keynes objected to the classical formulation of employment theory, particularly, Pigou’s notion that unemployment will disappear if the workers will just accept sufficiently low wage rates (i.e., a voluntary cut in money wage). He rejected Pigou s plea for wage flexibility as a means of promoting employment at a time of depression. 11/19/2023 34

35. 1.8.2 Keynes Theory 11/19/2023 35

36. 1.8.2 Keynes Theory 11/19/2023 36

37. 1.8.2 Keynes Theory 11/19/2023 37

38. Contd. 11/19/2023 38

39. Keynesian Model 11/19/2023 39

40. Contd. 11/19/2023 40

41. Money wage Vs Real wage Labours are generally paid a certain sum of money per day or week,month etc. The amount of money paid is called the money wages. The / Labour , however, is more interested in the goods and services which he can get with his money wages or otherwise. The amount of goods and services which the labourer actually gets is called his real wages. The standard of living and the prosperity of a labor depend not on his money wages but on his real wages. 11/19/2023 41

42. Classical Vs Keynesian Theory 11/19/2023 42

43. Classical Vs Keynesian Theory 11/19/2023 43

44. Classical Vs Keynesian Theory 11/19/2023 44

45. Contd. 11/19/2023 45

46. Contd. RQ 1: Explain Law of Market as per classical Economists RQ 2: Distinguish between Keynesian Theory and Classical theory RQ 3; How do you make difference between real wage and money wage? 11/19/2023 46

47. 1.8.3 Musgrave theory Musgrave, widely regarded as the founder of modern public finance and an adviser on fiscal policy and taxation to governments. Musgrave's theory broke down governmental economic activity into three parts : the allocation of resources ; the distribution of goods and services ; and the stabilization of the broader economy So, According to Professor Musgrave there are three major fiscal or budgetary functions of the governments. They are: a) Allocation functions b) Distribution functions and c) Stabilization functions 11/19/2023 47

48. Contribution of Musgrave Theory The use of fiscal instruments to secure adjustments in the allocation of resources between private and public goods; The use of fiscal instruments to secure proper adjustments in the distribution of Income and wealth; and The use of fiscal instruments to secure economic stability and growth 11/19/2023 48

49. 1.9 Allocation and distribution An allocation is efficient if it is impossible to reallocate resources such that one person can be made better off without making at least one other person worse off. Moreover, the people themselves must be the judges of whether they are better or worse off, by the principle of consumer sovereignty. An immediate outcome is that the government should pursue all pareto -superior allocations, those that make at least one person better off without making anyone else worse off. This is the basic concept of Pareto-optimality. 11/19/2023 49

50. 1.10 Pareto Optimality and Social Optimality Pareto-optimality , a concept of efficiency used in the social sciences , including economics and political science , named for the Italian sociologist Pareto. A state of affairs is Pareto-optimal (or Pareto-efficient) if and only if there is no alternative state that would make some people better off without making anyone worse off. More precisely, a state of affairs x is said to be Pareto-inefficient (or suboptimal) if and only if there is some state of affairs y such that no one strictly prefers x to y and at least one person strictly prefers y to x . Vilfredo Pareto . 11/19/2023 50

51. Contd. The concept of Pareto-optimality thus assumes that anyone would prefer an option that is cheaper, more efficient, or more reliable or that otherwise comparatively improves one’s condition. 11/19/2023 51

52. 1.11 Good Governance- – Accountability and Transparency Governance refers to all processes of governing, the institutions, processes and practices through which issues of common concern are decided upon and regulated. Good governance adds a normative or evaluative attribute to the process of governing. From a human rights perspective, it refers primarily to  the process whereby public institutions conduct public affairs, manage public resources and guarantee the realization/ensuring of human rights.   Example 11/19/2023 52

53. Key attributes of good governance The Human Rights Council has identified the key attributes of good governance: transparency responsibility accountability participation responsiveness (to the needs of the people) RQ: Define Good Governance- Key attributes of good governance 11/19/2023 53

54. “Transparency ”& “Accountability” Transparency ” is government's obligation to share information with citizens that is needed to make informed decisions/ issues and hold officials accountable for the conduct of the people's business. Transparency exists on government websites largely at the generosity of officials. 11/19/2023 54

55. Contd. Transparency implies openness, communication, and accountability. The term transparency has a very different meaning in information security where it is used to describe security mechanisms that are intentionally indetectable or hidden from view. 11/19/2023 55

56. Contd. To achieve transparency , an organization must provide information about its activities and governance to stakeholders that is accurate, complete and made available in a timely way. Transparency enables accountability . This does not mean all information should be made publicly available. RQ: How do you relate Good Governance, Accountability and Transparency in an economy? 11/19/2023 56

57. What is accountability? Accountability exists in a relationship between two parties where one has expectations of the other, and the other is obliged to provide information about how they have met these expectations or face the consequences of failing to do so. There are two components of accountability: Answerability – which means providing information and justification for how one’s actions align with expectations; and Enforcement – which means being subject to, and accepting the consequences of, failing to meet these expectations. 11/19/2023 57

58. Contd. However, accountability in an organization will involve multiple parties, it is important there is clarity about who is accountable to whom and how. The way this accountability is achieved will generally be set out in an organization's governing documents, such as its constitution, and any laws that apply to it. For example, an NFP may be required to provide an annual financial report to its regulator and the penalty for failing to do this may be a fine. 11/19/2023 58

59. Contd. It is important that the documents and policies that enable accountability are made available to relevant stakeholders. Subject to necessary confidentiality, usually this is done by providing such information on the organization's website, but it should be available on request at a minimum. For accountability to be achieved, there must be transparency . 11/19/2023 59

60. Maximum Social Advantage 11/19/2023 60

61. Contd. 11/19/2023 61

62. Contd. 11/19/2023 62

63. Review Questions 11/19/2023 63