public finance for undergraduate students.pptx

Public finance unit 1

1. Public Finance

2. Public Finance “ The task of economic stabilization requires keeping the economy from straying too far above or below the path of steady high employment . One way lies inflation, and the other lies recession . Flexible and vigilant fiscal and monetary policy will allow us to hold the narrow middle course.” (US president John F. Kennedy 1962)

3. The Concept Of Public Finance Public finance is a study of income and expenditure of the government at the central, state, and local levels. Government has to perform certain functions in a country such as to supply certain public or collective goods which individuals cannot or do not singly perform. And this is the responsibility of the government to provide those goods for which it needs revenue.

4. The Concept Of Public Finance In the narrow sense, public finance is defined only as the study of income and expenditure of the government. But the broader view is that public finance does not deal only with the income and expenditure of the government but also the sources of income and the way of expenditure of various government corporations, public companies, and quasi governmental ventures.

5. The Concept Of Public Finance

6. The Concept Of Public Finance Pu b lic finan c e i s c o mposed of t he following constituents: Public Expenditure : wages and salaries; subsidies and transfers; expenditure on goods and services such as infrastructures like road, electricity, telecom, and human capital accumulation like health and education; interest expenditure etc. Public Revenue: Different sources of government revenue with major focus on tax revenue. Public Debt: Often public revenue falls short of expenditure and government has to borrow from internal and external sources.

7. Public Expenditure

8. Public Revenue

9. Public Debt

10. The Concept Of Public Finance following Pu b lic finan c e i s c o mposed of t he constituents: 4. Public financial administration: As Walter Bagehot remarks money cannot manage itself, an efficient, energetic and scientific management is required to look after the public expenditure, public revenue and public debt. What are the authorities, institutions, agencies to look after the management, control, and scrutinizing work created by government? How do they keep check on the use and misuse of fund? Answer to all these questions relate public financial administration.

11. Public Financial Administration

12. The Concept Of Public Finance Public finance is composed of the following constituents: 5. Economic stabilization and economic growth: Maintaining stability and promoting balanced sustainable growth through the functions mentioned above is another constituent of public policy.

13. Economic Stabilization And Economic Growth

14. Role of The Government Role Of The Government Promotion of human capital accumulation Provision of essential public goods Decentralization Facilitating and regulating the private sector for promoting industries, financial institutions, and building infrastructures. Protections of individual liberties Private rights to land and capital Good courts and legal systems Representative political systems

15. In the absence of the government intervention, high rates of unemployment can persist for long periods Price level Output (GDP) Aggregate Supply Markets may tolerate equilibrium output (Y) less than full employment output (Y F ) Aggregate Demand Y Y F

16. How Does Government Work? With policy : Macroeconomic policy Fiscal policy Monetary policy Infrastructure investment Microeconomic policy Social investment and labour policy Industrial policy Competition policy

17. Government Budgeting Derived from Latin word „Bague‟ and French word „ Bougette‟. „Bougette‟ means small leather bag. Budget provision initially introduced in the UK. In 1733, the then Chancellor of Exchequer Walpole came with the leather bag in the parliament to present the annual statement of income and expenditure, and when he opened bag people used the term he is opening the budget. Thus, the term budget became popular.

18. Government Budgeting

19. Government Budgeting Budget is a financial statement of the government comprising expenditures and revenues for a year. It is both economic as well as political document. It is a mirror to look into development activities undertaken by the government, which sets a framework for policy formulation and implementation. Budget document is a good source of public information on past activities, current decisions, and future prospects.

20. Government Budgeting

21. Government Budgeting A good budget document contains : ( a) overall development policy , ( b) size and composition of revenue and expenditure, and policy , ( c) size and composition of external and internal borrowings, and policy , ( d) whether budget is deficit or surplus and how is deficit covered and surplus disposed of ? ( e) actual of the previous year, revised estimates of the current year and estimates for the next fiscal year.

22. Government Budgeting The main components of budget are government expenditures and government revenues. The expenditures are classified into : ( a) object classification , ( b) functional classification ( c) economic classification. The object classification includes expenditure on personal compensation and benefits; travel and transportation of persons and things; communication, utilities and rent; printing and reproduction; supplies, and materials; equipment; grant subsidies and contributions; insurance claims and indemnities, and reimbursable etc.

23. Government Budgeting

24. Government Budgeting c o m p rised of Functional classification e x p e n ditures on g e n eral is p u b lic se r vices and economic services. The general public services include: expenditure on defense, education, health, social security and welfare, housing and community amenities, and other community and social services. Likewise, economic services consist of expenditures on agriculture, mining, manufacturing, electricity roads, water transport, railways, communications, interest on the public debt and so on.

25. Government Budgeting Economic classification consists of : (a ) current expenditures , ( b) capital expenditure, and (c) principal repayment . The current expenditures include expenditures on goods and services such as wages and salaries, other purchases of goods, interest payments, subsidies and other current transfers. Capital expenditures include acquisition of new and existing fixed assets, purchase of stocks (inventories), purchase of land and intangible assets, and capital transfers.

26. Government Budgeting R e ve n ues are c l a s sified int o : tax and non-tax revenues. Tax revenues constitute both direct and indirect taxes. The premier direct taxes are on net income, property, and capital gains . Major indirect taxes include taxes on goods and services (VAT, excise etc), taxes on international trade and transactions (export and import duties). Non tax revenues constitute income from public enterprises, sales of government property, administrative fees, fines, penalties and royalties etc.

27. Elements Of Budget

28. Government Budgeting Elements Of Budget: Close to reality: despite being an estimate, it should be based on reality primarily on the basis of the experience of the previous year. Simple and obvious: Since this is a public document, all who are interested should easily get the required information after looking on it. Flexibility: Not only income and expenditure estimates are there but also the policies and programs of the government. Thus, should have the quality of flexibility.

29. Government Budgeting Elements of budget : Single fund: A single fund of the government should be established there for all revenues and expenditures. Extensiv e : Should be i n deta i l a b out each item of revenue and expenditure. Pu b li c it y : i t i s made pu b lic and all the stakeholders are free to comment on this. Annularity: Prepared for one fiscal year.

30. Government Budgeting Principles of budget: Balanced budget principle: Classical economists opine that government budget should be balanced that means expenditure ( G) should be equal to revenue (T). If not followed, either government has to borrow internally or externally or has to increase the tax. Supporters of balanced budget argue that unbalanced budget creates disturbances in economy.

31. Principles o f Budget

32. Government Budgeting Principles of budget : Principle Of Unbalanced Budget : A budget deficit is incurred when expenditures exceed taxes and other revenues for a year. And a budget surplus occurs when all taxes and other revenues exceed expenditures for a year. Though unbalanced means both surplus or deficit budget, a number of economists refer to deficit budget as unbalanced budget. Keynes has supported this principle arguing that along with the higher government expenditure, there will be multiplier effect in the economy.

33. Government Budgeting Bud g et Enactment or legislation E x ec u tion Accounting A u d i ting c y cle Evaluation Estimate

34. Components Of Budget • Revenue Receipts • Capital receipts • Revenue expenditure • Capital expenditure Thus A Budget Has Two Main Components [A] Receipts , [B] Expenditure.

35. Receipts •A. Revenue Receipts • 1. Tax Revenue • 2. Non –Tax Revenue •B. Capital Receipts • 3.Recovery Loans • 4.Other Receipts • 5.Borrowing & Other Liabilities • Total Receipts = A+B

36. Receipt Items Of The Budget

37. Receipts

38. Revenue Receipts

39. Tax Revenue Tax Revenue Includes All The Revenues Earned Through Various Kinds Of Taxes. Taxes Are Broadly Divided Into Direct & Indirect Taxes.

40. Taxation Tax Revenue: Taxes are the most important source of government income. Taxes can be defined as "a compulsory contribution imposed by a public authority, irrespective of the exact amount of service rendered to the taxpayer in return." According to Professor Seligman, a tax is "a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to special benefits conferred."

41. Direct Taxes 1. Corporation Tax 2. Income Tax 3. Interest Tax 4. Wealth Tax 5. Gift Tax 6. Expenditure Tax

42. Indirect Tax 1. Custom Duties 2. Excise Duties 3. Sales Tax 4. Service Tax

43. Non Tax Revenue It Includes The Revenue Accruing To The Government From Sources Other Than Tax. These Are ; 1. Interest Receipts 2. Dividends 3. Grants 4. Fines

44. Capital Receipts These Include Borrowing Of The Government. Since These Receipts Have To Be Repaid By The Government ,The Capital Receipts Are Liabilities. Capital Receipts Include Public Borrowing , Recivery Of Loans And Resale Of Shares And Bonds Held By The Government.

45. Expenditure Items

46. Expenditure Items

47. Revenue Expenditure It Is The Expenditure Incurred For The Day-to-day Functioning Of The Government Departments And Various Services Offered To The People, Payment Of Interest On Borrowings, subsidies Etc. Revenue Expenditure Will Not Result In The Creation Of Assets

48. Capital Expenditure Capital Expenditure Is The Expenditure Incurred On Creating Permanent Assets. Such Expenditure Is Incurred On Items Like Construction Of Buildings, roads, bridges, canals, Power Plants, capital Equipments

49. Deficit Financing Budget deficit is the annual difference between government outlays and receipts (G-T). The government budget constraint identifies financing options open to the government: G= T+∆B +∆MB Where , G=Total government expenditure. T=Total government revenue from taxes, charges, and sales. ∆B=Change in public debt ∆BM= Change in monetary base (Reserve money)

50. Deficit Financing G-T= ∆B +∆MB The idea is that if the government spends more than the revenue either it should borrow or create base money or do both. If the government is in surplus, it will either retire debt or contract the monetary expansion. Borrowing from the domestic sector can have also crowding out, the idea that increase in government purchases ultimately cause reductions in private consumption or investment. Monetary expansion to finance the government deficit can have inflationary implications.

51. Deficit Financing

52. Deficit Financing Government borrowing can be made raising through internal debt or external debt. Budget deficit financing identity: Budget deficit=Domestic borrowing+ foreign borrowing+ printing money + +arrears

53. Deficit Financing In other words, government deficit can be financed through following sources: 1. Withdrawal of past accumulated cash balances by the government. 2. Borrowing from public 3. Borrowing from central bank and other banks 4. Issuing new currency 5. External loan 6. Forced savings

54. Deficit Financing ( Role of deficit financing): To augment rate of net investment (particularly in developing countries, private sector is not proactive to take investment initiative because of the various constraints, thus there is the large role of the government and has to ) Development of economic and social overheads To control economic depression Reconstruction of the economy Augment community savings Incentive to private investment Utilization of the natural resources War financing

55. Role Of Deficit Financing

56. Effects Of Deficit Financing Inflation: expansion of money supply and expansion of credit leads to inflation. Crowding out of the private investment: Excessive reliance on public borrowing creates distortion on investment of the private sector and may also cause high interest, additional disincentive for investment. Balance of payments difficulties: As monetary income of the people rise, and also because of the rise in government expenditure, imports may rise causing an adverse effect on balance of payments. Increases debt servicing: Causing high government expenditure and pushes country towards vicious circle of debt and deficit. And also challenges long term debt sustainability.

57. Effects Of Deficit Financing Arrears: Past accumulated debt if can not be repaid because of the increased deficit, it causes inefficiency and loss of creditability. Rises tax burden to finance debt service, which creates distortions in the behavior of economic agents.

58. Effects Of Deficit Financing

59. Fiscal Policy Fiscal policy means setting of the taxes and public expenditures to help dampen the swings of business cycle and contribute to the maintenance of a growing , high employment economy, free from high or F i sc a l policy ope r ates vola t ile in f latio n . through ch a nges in government taxa t ion, and publ i c exp e n d itures, borrowings.

60. Fiscal Policy

61. Objectives Of Fiscal Policy Optimum allocation of resources: economic resources such as man, material, money should be used wisely and productively. Should avoid wastage of resources and ensure maximum productive employment of economic resources. Price stability: Falling prices (deflation) lead to decline in economic activity, while steeply rising prices (inflation) hit hard the fixed income groups. Fiscal policies should aim at securing price stability by fighting against inflationary or deflationary tendencies in the economy.

62. Objectives Of Fiscal Policy

63. Objectives Of Fiscal Policy Equitable distribution of income and wealth: The fiscal policies should be designed in such a manner that inequalities between rich and poor should be minimum. It should serve to secure equitable distribution of income and wealth among various sections of the society and geographical regions. Full Employment : This is possible if the economy attains its economic growth in commensurate with the growth rate of population. The fiscal policy be designed in such a manner that the rate of increase in income, and hence the rate of increase in employment opportunities is much higher than the growth rate of population.

64. Equitable Distribution Of Income And Wealth

65. Full Employment

66. Objectives Of Fiscal Policy Eco n omic Gr o wth : Less dev e lo p e d countries are caught in the vicious cycle of pover t y growth because of the low economic prima r i ly caused by low ca p ital formation, low human capital accumulation, and lack of technology. Thus, the fiscal policy should be oriented towards attaining higher sustainable growth.

67. Eco n omic Gr o wth

68. Instruments Of Fiscal Policy Fiscal policy seeks to achieve national economic objectives through changes in taxes, or changes in government expenditure, or a combination of ( a) taxes , ( b) government expenditure, and ( c) public debt . These instruments are used to influence national income, output, employment, and prices. Taxes, besides bringing revenue to the government, can be used to encourage or restrict private expenditures on consumption and investment.

69. Instruments Of Fiscal Policy

70. Instruments Of Fiscal Policy Government expenditure, may take different forms such as recurrent expenditure, capital expenditure etc. These expenditures have income creating effect. Increased government spending raises income directly, and so indirectly through multiplier process. Management of public debt influences aggregate spending through changes in the liquid asset position of the public. Public borrowing leads to tighter credit by reducing loanable funds otherwise available, and may have crowding out effect. But the expenditure of these borrowed funds by the government eliminates the tightening effect.

71. Types Of Fiscal Policy Usually classified as: expansionary vs. Contractionary, and discretionary vs. automatic (built in stabilizers). Expansionary fiscal policy : This increases AD either by increasing government expenditure (G) or reducing tax. Thus, the impact is either the budget deficit is increased or surplus budget is reduced. During the periods of recession or depression, government follows expansionary policy to boost income, output and employment. Contractionary fiscal policy: Government reduces expenditure or increases tax particularly to offset the effect of inflationary gap.

72. Expansionary Fiscal Policy

73. Types Of Fiscal Policy Dis c r e t ion a ry fi s c a l p o l ic y : Dis c r e tio n a r y fi s cal p ol i cy is t h e d e libe r ate a nd con s c i o u s attempt b y the g o vernme n t to promote full employment and price stability by contracyclical change in public expenditure or taxes or both. Discretionary fiscal policy change requires specific legislation. During depression, the effective discretionary policy may take four alternative forms : ( a) reducing tax rates and leaving g o v e r n ment e x p e n d it u r e s u n c ha n g e d , ( b ) incre a s i n g government expenditures and leaving tax rates unchanged, (c) simultaneously increasing government expenditures and reducing taxes, and (d) Increasing taxes and government expenditures both. During inflation, reverse of the above measures are suggested.

74. Types Of Fiscal Policy Automatic fiscal policy or built-in stabilizers : This policy operates through the built-in stabilizers to contract fluctuations in economic activity. Built-in stabilizers are those factors which automatically cause government expenditure to rise and tax receipts to fall during economic contraction and cause government expenditure to fall and tax receipts to rise during economic expansion. The important built in stabilizers are: progressive income tax, and unemployment compensation. During expansion, people pay high income tax and vice versa. Similarly, during contraction more people join the queue for unemployment benefit and vice versa.

75. Automatic Fiscal Policy Or Built-in Stabilizers

76. References Engineering Economic Analysis –NPTEL http://nptel.ac.in/courses/112107209/ Engineering Economics http://www.inzeko.ktu.lt/index.php/EE Fundamentals of Economics and Management Institutes of Cost Accountants of India www.icmai.in Modern Economics : Dr. H. L. Ahuja Principles for Macro-economics- C Rangarajan

77. Public Finance…