Public finance

Public finance is the study of the role of the government in the economy.[1] It is the branch of economics that assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones.[2] The purview of public finance is considered to be threefold, consisting of governmental effects on:[3]

  1. The efficient allocation of available resources;
  2. The distribution of income among citizens; and
  3. The stability of the economy.

Economist Jonathan Gruber has put forth a framework to assess the broad field of public finance.[4] Gruber suggests public finance should be thought of in terms of four central questions:

  1. When should the government intervene in the economy? To which there are two central motivations for government intervention, Market failure and redistribution of income and wealth.[5]
  2. How might the government intervene? Once the decision is made to intervene the government must choose the specific tool or policy choice to carry out the intervention (for example public provision, taxation, or subsidization).[6]
  3. What is the effect of those interventions on economic outcomes? A question to assess the empirical direct and indirect effects of specific government intervention.[7]
  4. And finally, why do governments choose to intervene in the way that they do? This question is centrally concerned with the study of political economy, theorizing how governments make public policy.[8]

==Overview== One of the more traditional subfields of economics, public finance emphasizes the function and role of government in the economy. A region's inhabitants established a formal or informal entity known as the government to carry out a variety of tasks, including providing for social requirements like education and healthcare as well as protecting the populace's private property from outside threats.

The proper role of government provides a starting point for the analysis of public finance. In theory, under certain circumstances, private markets will allocate goods and services among individuals efficiently (in the sense that no waste occurs and that individual tastes are matching with the economy's productive abilities). If private markets were able to provide efficient outcomes and if the distribution of income were socially acceptable, then there would be little or no scope for government. In many cases, however, conditions for private market efficiency are violated. For example, if many people can enjoy the same good (the moment that good was produced and sold, it starts to give its utility to every one for free) at the same time (non-rival, non-excludable consumption), then private markets may supply too little of that good. National defense is one example of non-rival consumption, or of a public good.[9]

"Market failure" occurs when private markets do not allocate goods or services efficiently. The existence of market failure provides an efficiency-based rationale for collective or governmental provision of goods and services.[10] Externalities, public goods, informational advantages, strong economies of scale, and network effects can cause market failures. Public provision via a government or a voluntary association, however, is subject to other inefficiencies, termed "government failure."

Under broad assumptions, government decisions about the efficient scope and level of activities can be efficiently separated from decisions about the design of taxation systems (Diamond-Mirrlees separation). In this view, public sector programs should be designed to maximize social benefits minus costs (cost-benefit analysis), and then revenues needed to pay for those expenditures should be raised through a taxation system that creates the fewest efficiency losses caused by distortion of economic activity as possible. In practice, government budgeting or public budgeting is substantially more complicated and often results in inefficient practices.

Government can pay for spending by borrowing (for example, with government bonds), although borrowing is a method of distributing tax burdens through time rather than a replacement for taxes. A deficit is the difference between government spending and revenues. The accumulation of deficits over time is the total public debt. Deficit finance allows governments to smooth tax burdens over time and gives governments an important fiscal policy tool. Deficits can also narrow the options of successor governments. There is also a difference between public and private finance, in public finance the source of income is indirect, e.g., various taxes (specific taxes, value added taxes), but in private finance sources of income is direct.[11]

  1. ^ Gruber, Jonathan (2005). Public Finance and Public Policy. New York: Worth Publications. p. 2. ISBN 0-7167-8655-9.
  2. ^ Jain, P C (1974). The Economics of Public Finance.
  3. ^ Oates, Wallace E. “The Theory of Public Finance in a Federal System.” The Canadian Journal of Economics / Revue Canadienne D'Economique, vol. 1, no. 1, 1968, pp. 37–54
  4. ^ Gruber, J. (2010) Public Finance and Public Policy (Third Edition), Worth Publishers, Pg. 3, Part 1
  5. ^ Gruber, J. (2010) Public Finance and Public Policy (Third Edition), Worth Publishers, Pg. 3, Part 1
  6. ^ Gruber, J. (2010) Public Finance and Public Policy , Worth Publishers, Pg. 6, Part 1
  7. ^ Gruber, J. (2010) Public Finance and Public Policy (Third Edition), Worth Publishers, Pg. 7, Part 1
  8. ^ Gruber, J. (2010) Public Finance and Public Policy (Third Edition), Worth Publishers, Pg. 9, Part 1
  9. ^ Tresch, Richard W. (2008). Public Sector Economics. New York: PALGRAVE MACMILLAN. pp. 143pp. ISBN 978-0-230-52223-7.
  10. ^ Hewett, Roger (1987). "Public Finance, Public Economics, and Public Choice: A Survey of Undergraduate Textbooks". The Journal of Economic Education. 18 (4): 426. doi:10.2307/1182123. JSTOR 1182123.
  11. ^ businessfinancearticles.org

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