Download Course Title: Public Finance Chapter 1: Introduction to public

Course Title: Public Finance
Chapter 1: Introduction to public finance
Additional Reading 2
1. Introduction to public finance
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There are 3 critical points, I wish to share with your with regard the introduction to public
finance in this part.
The first is “relevant topics including in study public finance”
The second is “definition and concepts of the public finance”
The third is “the people view of public finance”
2. Topics including in public finance
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Public finance is about how the government raises funds and spends the money on various
kinds of services for the economy and society.
In this sense, it shows off the government action in the market, which is normally know as
“government intervention”.
Therefore, the relevant topics including in the public finance are those of:
• public revenues generation or tax collection,
• public goods and markets with externalities,
• subsidized education,
• public health or health care,
• social security, and
• income redistribution.
3. Definition and concept of public finance
 What is Public Finance?
• Public Finance, field of economics concerned with how government raises money, how
that money is spent, and the effects of these activities on the economy and on society.
• Public Finance studies how government at all level--national, state, and local--provide
the public services desired and how they secure the financial resources to pay for these
services delivery.
• As evidence, in many industrialized countries, spending and taxation by the government
form a large portion of the nation’s total economic activities.
• For example, total government spending in the United States equals about 40% of the
nation’s GDP.
 Why Public Finance is needed?
• Government provides public goods--government financed goods and services such as
roads, military forces, education, health care, social welfare, lighthouses, and street
lights, etc.
• Private Citizens would not voluntarily pay for these services, and therefore businesses
have no incentive to produce them.
• Public finance also enables government to correct offset undesirable side effects of a
market economy.
• These side effects are called “spillovers or externalities”.
• Example: households and industries may generate pollution and release it into the
environment without considering the adverse effect pollution has on others.
• Pollution is a spillover because it affects people who are not responsible for it.
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To correct spillover, government can encourage or restrict certain activities.
For example, governments can sponsor recycling programs to encourage less pollution,
pass laws that restrict pollution, or impose charges or taxes on activities that cause
pollution.
• Public finance provides government programs that moderate the income of wealthy and
the poor.
• These programs include social security, welfare, and social programs.
• For example, some elderly people or people with disabilities require financial assistance
because they cannot work.
• Government redistributes income by collecting taxes from their wealthier citizens to
provide resources for their needy ones.
• The taxes fund programs that help support people with low income.
 Public Spending
• Each year national, provincial, and local government creates a budget to determine how
much money they will spend during the upcoming year.
• The budget determines which public goods to produce, which spillovers to correct and
how assistance to provide to financially disadvantaged people.
• The chief administrator of government--such as the prime minister, the governor, or the
mayor--proposes the budget.
• The legislature--such as the parliament, provincial council, municipality council, district
council, or commune council--ultimately must pass the budget.
• The legislature often changes the size and composition of the budget, but it must not
make change that the chief administrator will reject and veto.
• Government spending takes two form: Exhaustive spending and Transfer.
 Exhaustive spending:
• Refers to purchases made by a government for the production and/or creation of public
goods or services
• For example, to construct a new harbor, the government buys and uses resources from
the economy, such as labor and raw materials.
 Transfer spending:
• Refers to a type of spending when the government transfers income to people to help
them support themselves.
• Transfers can be taken in one of two kinds: cash or in-kind.
• Cash transfers are cash payments, such as social security checks and welfare
payments, health care coupon for the poor, for example.
• In-kind transfers involve no cash payments but instead transfer goods or
services to recipients. Example of in-kind transfers includes food stamp
coupons and Medicare.
 Public Revenue
• Government must have funds or revenues to pay for their activities.
• Government generates some revenues by charging fees for the services they provide,
such as entrance fees at national parks, national museum, or tolls for using a highway.
• However, most government revenues come from taxes, such as income taxes, capital
taxes, and sales and excise taxes.
• An important source of tax revenues in most industrialized countries is the income or
payroll tax, which is also known as the “personal income tax”.
• Income taxes are imposed on labor or activities that generate income, such wages or
salaries.
• As evidence, in the United States, income taxes account for about half of the total
revenues of local, state, and federal government combined.
• Another important source of government revenue is the capital tax.
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Capital includes items or facilities that generate profits, such as factories, business
machinery, and real estate.
• Some types of capital taxes are known as “Profits” taxes.
• One kind of capital tax used by the federal government in the United States is the
corporate income tax.
• A property tax is a capital tax used by states and local government. Property taxes are
levied on items such as houses or boats.
• Sales and excise taxes are also a major source of government tax revenues.
• Many state and local government levy a sales tax on the purchase of certain items.
• Consumers usually pay a percentage of the sale price taxes are used by levels of
government.
• An excise tax is levied on a specific product, such as alcohol, cigarettes, or gasoline.
• In Canada and many European, South American, and Asian countries, a value-added tax
(VAT) provides significant revenues.
• The VAT is levied on the value added to product during production as its components
are assembled into final goods.
• For example, a clothing manufacturer might spend $ 500 on fabric, thread, zippers, and
other goods required to make dresses. The manufacturer then adds $1000 to cover the
cost of labor and the use of the machines and equipment and sells the dresses for a total
cost of $1500. The value-added tax is paid on this $1000.
 How Public Finance Affects the Economy?
• Government spending and taxation directly affect the overall performance of the
economy.
• For example, if the government increases spending to build a new highway, then the
construction of the highway will create jobs. Jobs create income that people spend on
purchase, and then the economy tends to grow.
• The opposite happens when the government increases taxes. Households and business
have less of their income to spend, they purchase fewer goods, and economy tends to
shrink.
 Fiscal Policy
• A government’s fiscal policy is the way the government spends and taxes to influence
the performance of the economy.
 Government Deficits
• When the government spends more than it receives, it runs a deficit.
• Government finances deficits by borrowing money, which is also called “deficit
spending”.
• Deficit spending refers to spending funds which is obtained by borrowing instead of
taxation.
• Deficit spending can be helpful for the economy.
• Example:
• When unemployment is high, the government can undertake projects that use
workers who would otherwise be idle.
• The economy will then expand because more money is being pumped into it.
• However, deficit spending also can harm the economy.
• When unemployment is low, a deficit may result in rising prices, or inflation.
The additional government spending creates more competition for scare workers
and resources and this inflates wages and prices.
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Public finance is a subject that study on the way in which the government is normally used
to raise funds and how they spend those money on various kinds of services for the
economy and society, or in other word for public service delivery.
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So public finance is concerned with The revenue and expenditure of the government.
What is the government?
The government is referred to as public sector or a collection of all household family and
other in a countries.
• In economics, how large or small the government or the public sector’s size is measured in
comparison to as percentage of the amount of public expenditure to GDP.
4. People view on public finance
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Different people have different point of views.
Therefore, we can view the same thing in different way.
It is the same for the view of Public Finance or Government.
In other word, the views of how government should function in the economic sphere are
influenced by ideological views concerning the relationship between the individual and the
state.
In the sense, political philosophers have distinguished two major approaches, which is called
“Organic view of government and Mechanistic view of government”
These two ideological approaches have influenced the people’s view on the “Public Finance
or Government”.
What is the organic view of government—public finance?
And what is the mechanistic view of government—public finance?
4.1. Plato, Philosopher
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Plato was a philosopher in Classical Greece, born in 427 BC and died in 347 BC in Athens
of Greece.
He was also a mathematician, student of Socrates, writer of philosophical dialogues, and
founder of the Academy in Athens, the first institution of higher learning in the Western
world. (Wikipedia)
4.2. Adam Smith, Philosopher
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Adam Smith was a Scottish moral philosopher and a pioneer of political economy, born in
1723 in Kirkcaldy and died in 1790 in Edinburgh of UK.
One of the key figures of the Scottish Enlightenment, Adam Smith is best known for two
classic works: The Theory of Moral Sentiments (1759), and An Inquiry into the Nature and
Causes of the Wealth of Nations (1776).
The latter, usually abbreviated as The Wealth of Nations, is considered his magnum opus
and the first modern work of economics.
Smith is cited as the "father of modern economics" and is still among the most influential
thinkers in the field of economics today. (Wikipedia).
4.3. Vladimir Lenin, Revolutionary
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Vladimir Ilyich Lenin was a Russian communist revolutionary, politician and political
theorist, born in 1870 in Ulyanovsk of Russia and died in 1924 in Gorki Leninskiye, Russia.
He served as the leader of the Russian SFSR from 1917, and then concurrently as Premier of
the Soviet Union from 1922, until his death. (Wikipedia).
4.4. Adolf Hitler, Former Chancellor of Germany
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Adolf Hitler was an Austrian-born German politician and the leader of the Nazi Party, born
in 1889 in Braunau am Inn, Austria and died in 1945, Berlin, Germany.
He was chancellor of Germany from 1933 to 1945 and dictator of Nazi Germany from 1934
to 1945. (Wikipedia).
5. Organic view of government
 Organic view of government is the idea of conceiving the government form in comparison
to an organism or body of human being.
 Society is a natural organism, each individual is part of the organism, and the government is
the heart of the organism.
 In this case, In an organic view of government, individuals are valued only by their
contribution to the realization social goals. These goals are determined by the government.
 It means that individuals are important only as part of the society, and the good of the
individual is subordinate to the good of society.
 Society or community is above the individual. The objectives or goals of a society are set
by government.
 The problem with this approach of view is that “who is to represent the government”.
 In this sense, there are three kinds of choices to be considered:
• Plato: realization of perfect rationality.
• Hitler: realization of racial purity.
• Lenin: realization of socialism
 Social objectives can be distinguished, and the most important thing is how to choose
the objectives of the society.
 Still, in spite of the many philosophers, it is not clear what is natural for fulfilling a
whole society.
6. Mechanistic view of government
 Mechanistic view of government
 What does it mean, the mechanistic view?
 Mechanistic view is another ideological approach of viewing government or public
finance.
• In this approach, government is not an organic part of society. Rather, it is a contrivance
created by individuals to better achieve their individual goals.
• The point here is that government is a contrivance (plan or fabrication) erected or created
to further (advance) individual goals. In this sense, it is not yet clear how the government
can reconcile and sometimes there is even conflicts of individual goals.
• However, At the center, attention here is the individual, not the group, not the society. It
means that “the individual rather than the group is at center stage”.
• Therefore, the government exists for the good of the nation, but the problem is that “what
is good and how government should achieve it”.
• The effort is that “ the government is trust, the state servants are trustees, and trust and
trustees have been created for the wellbeing welfare of the nation”.
• The general consensus here is that: it is good for individuals when the government
protects them from violence, for which reason it must have the power of coercion
(enforce or command), otherwise there will be anarchy.
 In this regard, there are many debates and arguments along with this mechanistic view
of government.
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• Government is needed for individuals to pursue their individual goals. Those goals are to
have “Efficient markets”. It means property rights and lack of violence is needed to have
efficient markets (see Adam Smith “Invisible hand”)
• Adam Smith in his work called Wealth of Nations published in 1776 claimed that
“government should protect a society against violence and the assaults (invade) of other
independent societies… and every member of the society against injustice and oppression
(abuse or misery) from any other member of the society.”
• However, J. S. Mill held (raised) that “the only reason for which a government should
use its power to coerce any member of society against his will is to prevent him from
injuring others.”
• But the point is that: “what is injury to others, and how great must this injury be to
justify the use of state coercion?”
• The answer is that: the minimum that government should provide is protection and the
infrastructure necessary for the life of society. For example, lighthouses, roads, bridges,
and the sewers ... etc. must be made available.
 Beyond this, how much government should do? Debatable!
• Within mechanistic view they distinguish into two forms “libertarian and social
democrats”.
• Liberals, libertarians – those who believe in a very limited government and they argue
against any further economic role for government.
• In classic liberals-government is legitimate (lawful or legal), but it oversteps (performs
beyond) its boundaries and hence we must be watchful (careful) over what government is
doing.
• In the eyes of libertarians – government is not a servant of society that sometimes errs,
rather it acts as enemy to society.
• In the sense, classic liberals argue for a limited government, for laissez for laissez faire
in combination with a limited but still active government.
• In American point of view, liberals are on the whole into race and gender orientation and
abortion, while British liberals are really social democrats.
• Adam Smith exclaim that “Every man, as long as he does not violate the law of justice, is
left perfectly free to pursue his own interest his own way”.
• It means that libertarians are extremely skeptical or doubted about the ability of
governments to improve social welfare. This is why they need freedom as in the concept
of “invisible hand” of Smith.
• Social democrats – those who believe that substantial or firm government intervention is
required for the good of the individuals.
• It means that government intervention is considerably required to assure benefits sharing
to the unemployed or the disable through subsidies or other social security program. ...).
There is no hard and fast division, rather a sliding scale of view about the necessary scope
of government intervention.
• Now, then, which one is good? Which one should be selected to be used?
7. Government at glance
 Now, let’s see government at glance.
• As legal framework, government is created in accordance with the constitution, which is
a supreme law of the countries. Government can come to power through election or
nomination (parliamentary or presidential).
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• Base on the constitution, Cambodia is free market economy and democracy with
pluralism. Furthermore, we have laws, sub-laws, regulations, circulations and other legal
instruments.
• Another example, the constitution of Republic of Croatia – entrepreneurial and market
freedoms are the basis of the economic organization of the Republic of Croatia.
• With this regard, the government makes sure that all enterprises have equal legal status
on the market. The abuse of the monopolistic positions defined by law is forbidden. And
the government encourages economic development and the welfare of the local
governments and takes care of the economic development of all of is regions.
• As organizational framework and structures, government can be looked at various
level such, federal, national, state, regional and local. For Cambodia, we have only the
national and sub-national level.
• At the national level, it can be divided into ministry, institutions, committees, units
department. ... etc.,
• At the sub-national level, it can be provinces or cities, districts, communes and villages.
The important roles of government is to provide public services such as defense, health,
education; legislations; regulations; and market interventions, which we will see that in
detail in the following chapters.
How to measure the size of government?
All common measures of the size of government are employees (number of workers or
government servants), annual expenditures, annual revenues, etc.- which may be involved
some deficiency by the time. Nevertheless, there is strong evidence that the impact of the
government on the allocation of national resources has increased over time.
As summary, the size of the government can be measured through the following
measurements:
• Measurement via annual expenditure
• Purchase of goods and services
• Size of transfers (social and subsidy)
• Payment of interest
• Expenditure of general government
• Inflation-adjusted expenditure
• Government spending per capita
• Government spending as proportion (%) of GDP
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